A N G E L I N V E S T M E N T G R O U P S , N E T W O R K S , A N D F U N D S : A G u i d e b o o k t o D e v e l o p i n g t h e R i g h t A n g e l O r g a n i z a t i o n f o r Y o u r C o m m u n i t y

A U G U S T 2 0 0 4 E D I T I O N

I N A S S O C I A T I O N W I T H S U S A N L . P R E S T O N A N G E L I N V E S T M E N T G R O U P S , N E T W O R K S , A N D F U N D S : A G u i d e b o o k t o D e v e l o p i n g t h e R i g h t A n g e l O r g a n i z a t i o n f o r Y o u r C o m m u n i t y

A U G U S T 2 0 0 4 E D I T I O N

The author, Susan L. Preston, Esq., is an Entrepreneur-in-Residence of the Ewing Marion Kauffman Foundation. Ms. Preston has an extensive background in early-stage financing as an angel investor, founder of an angel organization, and counsel to numerous early-stage companies and investors.

©2004 Ewing Marion Kauffman Foundation. All rights reserved. T A B L E O F C O N T E N T S

I N T R O D U C T I O N ...... 1

B A C K G R O U N D ...... 2

F U N D A M E N T A L S ...... 6

B U I L D I N G T H E F R A M E W O R K ( C R E A T I N G Y O U R A N G E L G R O U P ) ...... 10 Community Assessment ...... 11 Selecting a Structure ...... 16 Decision Steps ...... 17 Member-Managed versus Manager-Managed ...... 17 Legal Structure ...... 20 Investment Structure...... 29 Determination of Membership ...... 30 Financial Resources: Funding Your Angel Organization ...... 35 Summary of Building the Framework ...... 38

G R O U P O P E R A T I O N S ( I M P L E M E N T I N G Y O U R A N G E L G R O U P ) ...... 4 0 Membership...... 40 Meeting Structure ...... 45 Group Budget ...... 46 Sponsorships ...... 48 Investment Evaluation and Process ...... 50 Summary of Group Operations ...... 57 A P P E N D I C E S

Sample Membership Information...... 1 Sample Membership Agreement ...... 2 Sample Membership Survey...... 3 Angel Investor Education Program Agenda ...... 4 Group Finances: Revenues and Expenses Worksheet ...... 5 Sample Funding Application ...... 6 Sample Screening Committee Worksheet ...... 7 Due Diligence Questions ...... 8 Due Diligence Checklist Table ...... 9 Glossary of Terms ...... 10 Investor Vs. Company Favorable Term Sheet Sample ...... 11 Explanatory Term Sheet Sample...... 12 Sample Public Survey...... 13

TABLES, GRAPHS, AND FIGURES

Table 1 – Equity Capital Sources for Entrepreneurs ...... 4 Graph 1 – National Venture Capital Investments, 2000-2003 ...... 4 Table 2 – Venture Capital Funds, 1995-2003 ...... 5 Table 3 – VC Seed and Start-Up Financings, 1999-2003 ...... 5 Table 4 – Angel Investor Reasoning ...... 7 Table 5 – Community Assessment Questions and Process ...... 12 Figure 1 – Decision Matrix for Creating an Angel Group ...... 16 Table 6 – Structural Pros and Cons ...... 17 Table 7 – Member-Led versus Manager-Led Groups...... 18 Table 8 – Legal Structure Comparison ...... 28 Table 9 – Creating Your Angel Group Summary...... 38 Table 10 – Organizational Activities and Duties ...... 43 Table 11 – Group Expenses ...... 46 Table 12 – AHI Tactics for Promoting Sustainability ...... 57 I N T R O D U C T I O N

F rom 1996 to 2003, the number of angel org a n i z a t i o n s 1 Despite a seeming morass of variables and choices, there in the United States increased significantly from an a re basic factors, decision points, and questions that estimated 10 to about 200 groups. This growth occurre d should help you determine the type of stru c t u re that best because individual angel investors found many suits you, your member base, and community. This advantages to working together — better investment Guidebook is intended to take you through a decision- decisions, enhanced deal flow, the ability to combine making process to determine the best stru c t u r e for you, their funds into larger equity investments, and gro u p p rovide examples of organizational stru c t u res and social attributes. Nearly all of these groups created their functions, and give you a head start in establishing your s t ru c t u re de novo having little or no guidance or best angel group with some critical documents and guidelines. practices to follow. To meet the need for inform a t i o n , One size does not fit all, however. So, after you have this Guidebook has been developed to help in the gone through the discussions, questions, and options establishment of angel groups most appropriate for outlined in this Guidebook and come to a conclusion for p rospective member investors and related community. It a particular step or factor, you may decide to choose a is designed to provide practical suggestions, tools, and different model just because your membership has a best practices in starting and operating an angel gro u p . greater comfort level with more or less structure at this Starting any type of group can be a daunting task. point in your organizational development. Recognition Establishing a successful angel group can be particularly and acceptance of the need for growth are important, d i fficult because angel groups are a recent phenomenon, and willingness to adjust your model, goals, and and angel investors are notoriously private. To make orientation will be important for your organization’s matters more confusing, many different organizational long-term success. models or structures have been successful. In addition, You should be sure to consult qualified counsel success is not necessarily measured by return on regarding federal, state, and local rules and regulations investment, since angels typically invest at an early stage, that may govern your organization. Attorneys and and returns may not be seen for several years. Instead, accountants can be invaluable to any organization, and success may be measured by factors such as member you should avail yourself of their knowledge and retention, investment rate, accomplishment of goals, background to ensure the legality and economic value and member satisfaction. of your angel group.2

1 Throughout this Guidebook, the terms “group” and “organization” are used interchangeably. 2 This Guidebook is intended to enhance the reader’s awareness of the variables and attributes of establishing and operating an angel organization and should not in any way be substituted for professional advice. One should retain appropriate regional counsel to ensure compliance with local, 1 state, and federal laws. B A C K G R O U N D

Angel investors have proven themselves to be an In the financial world today, angel investors are a critical integral part of the capital market, particularly for and essential part of a healthy economy, particularly for funding start-up companies and providing first-phase the establishment and growth of early-stage companies. financing of businesses. The term “angel” originated in Experts estimate that, on a cumulative basis, the level of the early 1900s and referred to investors who made investments made by angels over the last 30 years has risky investments to support Broadway theatrical been double that of investments made by venture productions. Today, the term “angel” refers to high-net capitalists.3 The Center for Venture Research (the worth individuals, or “accredited investors,” who “CVR”) at the Whittmore School of Business and typically invest in and support start-up companies in Economics at the University of New Hampshire4 their early stages of growth. estimates that angel investments for 2003 were approximately $18.1 billion in 42,000 deals, down from the historical — last 10 years — investment trend of D E F I N I T I O N : The term “accredited investor” under the Securities Act of 1933, approximately $30 billion per year in 50,000 ventures. as amended, includes the following definitions with regard to individual This investment amount is comparable to venture capital investors: “Any natural person whose individual net worth, or joint net worth funds, which, according to the National Venture Capital with that person’s spouse, at the time of his purchase exceeds $1,000,000”; and Association, invested $18.2 billion in 2003, with only “Any natural person who had an individual income in excess of $200,000 in 2% of those dollars in seed or early-stage investments. each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of In addition to the value provided by early funding, angel reaching the same income level in the current year.” With regard to investors are typically experienced professionals who can organizations, an accredited investor is: “Any organization described in offer wisdom and guidance to the entrepreneur and section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or who have the patience to allow time for normal similar business trust, or partnership, not formed for the specific purpose of company maturation. With few exceptions, angels invest acquiring the securities offered, with total assets in excess of $5,000,000.” on a regional basis, being interested in personal relationships with companies and employees, as well as in giving back to their communities.

3 According to statistics published by the National Venture Capital Association and the Center for Venture Research, University of New Hampshire. 4 Sincerest thanks and appreciation to Dr. Jeffrey Sohl, Director of the Center 2 for Venture Research, for permission to use selected results of the 2003 angel group survey. Angel groups, which have more re s o u rces than individual funding chain by not investing as early in a company’s angels, are playing a more crucial role in funding young development, a second funding gap has emerg e d companies, as well as in funding second-stage between $2 million and $5 m i l l i o n . 5 Added to this companies, leveraged buyouts, and spin-offs. Historically, p roblem of venture capitalists pre f e rring larger deals is the funding gap between investments made by friends the definitive drop in venture capitalists funding seed or and family and the point at which companies could s t a rt-up stage companies. The following table and realistically obtain financing from venture capitalists was graphs demonstrate this trend in the last few years of between $500,000 and $2 million in invested capital. significant decrease in venture capital funds both of Individual angels could often meet these funding needs. numbers of investments and of total dollars invested. H o w e v e r, with venture capitalists moving further up the

D E F I N I T I O N S : The definition of these various stages of business development and corresponding financing can vary between publications and individuals. For purposes of this Guidebook, the following definitions for stages of financing will be utilized from Pratt’s Guidebook to Venture Capital Sources; 2001 Edition, Thomson Financial/Venture Economics:

⁄ Seed financing “is a relatively small amount of capital provided to an inventor or entrepreneur to prove a concept and to qualify for start-up capital. This may involve product development and market research as well as building a management team and developing a business plan, if the initial steps are successful.” (By this definition, pre-seed financing would denote financing to help articulate the concept.)

⁄ S t a rt-up financing “is provided to companies completing product development and initial marketing. Companies may be in the p rocess of organizing, or they may already be in business for one year or less, but have not sold their product commerc i a l l y. Usually such firms will have made market studies, assembled the key management, developed a business plan and are ready to do business.”

⁄ Early- or first-stage financing “is provided to companies that have expended their initial capital (often in developing and market testing a prototype) and require funds to initiate full-scale manufacturing and sales.”

⁄ Expansion financing is second and subsequent investment rounds typically financing company product and/or market expansion, or keeping the company financially healthy shortly before a liquidity event such as an initial public offering (IPO) or acquisition.

5 Jeffrey E. Sohl, "The Private Equity Market Gyrations: What Has Been Learned?" Venture Capital: An International Journal of Entrepreneurial 3 Finance, Vol. 4, No. 4, 2002, pgs. 267-274. The relatively new funding gaps of $500,000 to $2,000,000 and most recently also $2,000,000 to TA B L E 1 Equity Capital Sources for Entrepreneurs $5,000,000, combined with the fairly recent precipitous drop in overall venture funding, has created a domino STAGE PRE-SEED SEED/ EARLY LATER effect of problems for early-stage companies, START-UP Funding Gaps: particularly for companies in late “start-up” or “first- Source Founders, Individual 1. Between $500,000 Venture Funds stage financing” phases of critical growth and and $2,000,000; Friends Angels momentum. Angel groups can be a solution. and Family 2. Between $2,000,000 Investment $25,000 to $100,000 to and $5,000,000 $2,000,000/ Few individual angels can accommodate the increased $100,000 $500,000 $5,000,000 and up dollar needs of growing entrepreneurial companies, particularly in the $2,000,000 to $5,000,000 range, before venture capitalists are considering investments, and at a time of critical growth for a young company. G R A P H 1 6 National Venture Capital Investments, 2000 - 2003 But, by combining resources of individual investors, angel groups can be the proverbial white knights. Funding this second gap of $2,000,000 to $5,000,000 typically requires a co-investment strategy, and angel groups can be a potential solution through the combined funding resources of a group of individual angel investors. These groups also have the combined manpower for analysis of multiple or complex investment opportunities, further aiding in making these investments possible.

6 Source: National Venture Capital Association 4 TA B L E 2 7 Venture Capital Funds, 1995 - 2003

YEAR TOTAL (BILLIONS) DEALS PER DEAL (MILLIONS) 1995 $7.7 1,874 $4.1 1996 $11.5 2,612 $4.4 1997 $14.8 3,185 $4.6 1998 $21.3 3,695 $5.8 1999 $54.3 5,608 $9.7 2000 $105.9 8,082 $13.1 2001 $40.6 4,600 $8.8 2002 $21.4 3,035 $7.1 2003 $18.2 2,715 $6.7

TA B L E 3 8 VC Seed and Start-Up Financings, 1999 - 2003

YEAR SEED & PERCENT OF SEED & PERCENT OF START-UP TOTAL TOTAL VC FUNDS START-UP DEALS TOTAL VC DEALS 1999 $3.3 billion 6.1% 809 14.4% 2000 $3.0 billion 2.9% 672 8.3% 2001 $767.0 million 1.9% 251 5.4% 2002 $352.0 million 1.7% 155 5.1% 2003 $354.0 million 2.0% 166 6.1%

7 Source: National Venture Capital Association 8 Source: National Venture Capital Association 5 F U N D A M E N T A L S

At first glance, angel groups come in as many shapes, Any successful angel group needs to address several sizes, styles, and structures as flavors of jellybeans. But i s s u e s : one factor does appear to be relatively constant: recent Ac c r edited Inve s t o r s : Angel groups can self-select by surveys of angel groups by the Center for Venture n u m e rous criteria, including industry focus, gender, or Research show that one of the primary criteria for other variables. But as statistics support, substantially all membership is net worth or accredited investor status of the gro u p ’s members should be “accredited investors” of the group members. Another constant and part of (see previous definition). The words “should be” are the definition that separates angel groups from other purposely used because there are few re g u l a t i o n s investment vehicles is the active participation of re g a rding the stru c t u r e or membership criteria for angel angel group members in the investment of their o r ganizations. These re q u i rements come into play, own capital. In contrast, venture capital funds, broker- h o w e v e r, at the time of investment. Companies typically dealers and investment bankers typically operate on a refuse investors that do not qualify as “accre d i t e d passive investor model — the individual is not actively investors,” in large part because of re g u l a t o ry involved in the investment decision-making process. i n f o rm a t i o n - d i s c l o s u re and re p o r ting re q u i rements and From this definition of active investment of one’s own the funding limitations imposed upon companies for capital, an angel group is, then, a group of angel acceptance of investments from non-accredited investors. investors investing through a member-directed Again, this does not mean that your members must be investment process. The actual investment direction a c c redited investors, but entre p reneurs will have less process may vary considerably, but all members have incentive or interest in presenting to your angel input either through their individual decision to invest or o r ganization or going through the arduous steps of due as a member of the group to invest part of the group’s diligence with a group that has only a minimal fund. Angel organizations can be everything from an p e rcentage of accredited, and thus potential, investors. informal group of individuals who conduct cooperative The accredited investor status requirement also relates due diligence to a group with paid management and to deal flow for your angel group. If your organization is committed investment funds. known for having active investors, high-quality potential investment deals are more likely to seek out your group for investment opportunity. In addition, accredited investors are often previously successful entrepreneurs, which is consistent with survey results showing that two other important criteria for membership are past investment experiences and member referrals of investable companies.

6 A Champion: A key factor in the success of an angel Clear Reasons for Forming the Angel Gro u p : organization is an appropriate and active champion. Along with having a committed individual or group, an One cannot over-emphasize the importance and understanding of why people become angel investors, necessity of an individual or small group of people to or conversely, why they shy away from angel investing, champion the establishment and instigation of your can be critically important in attracting members. angel organization. Often, the desire of those forming Understanding your community is also essential, and the angel group will influence the structure of the you should evaluate your community’s capacity to ultimate organization. They will also likely be the source support an angel organization. As to reasons for of other members with similar interests and confidence becoming or not becoming an angel investor, we look in your champion or founding group. Advisors are also at the results of the CVR 2003 angel group survey. extremely important, but an organization cannot get off Several questions were posed to existing angel the ground and succeed without a leader. Ideally, the organizations relating to angel investments. The results champion or group of champions should be accredited are telling as to why the number of angel organizations investors with influence and connections within the is on the rise. Table 4 lists the survey questions and the community sufficient to attract other accredited top three responses from angel groups. investors as potential group members. Although these questions were asked of existing angel TA B L E 4 o rganizations, the reasons for establishing an angel Angel Investor Reasoning g roup are the same, and the responses give good insight QUESTION TOP THREE ANSWERS into the reasons more angel groups are being form e d . What do you think are the main 1 . Lack of business proposals that match their ge n e ra l Along with providing the social aspects of gro u p reasons that business angel i n v e s t me nt criteria interaction, angel groups typically fulfill many of the investors do not make more 2. Lack of faith/trust in company founder/management needs of individual angel investors and the limitations investments? 3. Lack of quality business proposals associated with solo angel investing, including: Which of the following reasons do 1. T he opportunity to co-invest with othe r, mo re - ex p e r ie n c e d ⁄ Angel groups provide more efficient matching of you think motivate your investors investors entrepreneurs and investors. Market recognition of an most to invest? 2. The opportunity to learn from successful business angels angel group and its particular investment focus 3. More trust in company founder and management leverages this public presence and creates a network Mo re specific a l l y, add i t i o na l 1. Due diligence of members to increase quality deal sourcing and k n o w l e dge on which of the fo l l o w i ng comprehensive due diligence. 2. Pricing and structuring deals s t a g es of the investme nt process will motivate investors to invest? 3. Negotiating deals

7 ⁄ The efficiencies of group due diligence and investment U n d e r stand Why Your Colleagues Are Intere s t e d support cannot be emphasized enough. Individual in Being Angel Inve s t o r s: Even more basic than the deal screening is time consuming and inefficient. Few, question of why investors join angel groups is the if any, individual angel investors possess all the skills question of why people become angel investors. One and knowledge necessary to accurately and objectively noted publication9 ranks the motivations for angel evaluate an investment opportunity. Group evaluation investors in the following order of import a n c e : allows for “checks and balances” analysis by providing ⁄ Expectation of high financial reward. multiple points of knowledge about the market, management, and financial assumptions, and by ⁄ Playing a role in the entrepreneurial process. encouraging group members to challenge ⁄ Fun and satisfaction of being involved in an assumptions and opinions in a way not typically done entrepreneurial firm. by individual investors. ⁄ Creating a job for oneself, and possibly some income. ⁄ New angels can learn from experienced angel investors on all aspects and steps of investing. ⁄ Sense of social responsibility.

⁄ The combination of potential investment dollars either Along with contributing to group learning and through an actual angel fund or through collective dynamics, angel organizations can also fulfill the individual investors gives greater economic power and motivations of individual angel investors. All these influence, which enhances deal flow and investment- factors should be considered and constantly reviewed to terms negotiation. ensure the success of any angel organization. Understanding the fundamental psychology of angel Angel groups provide the intangible values of ⁄ investors will bode well in structuring your angel group. camaraderie and sharing of common goals.

Make sure that your angel group plans include a clear set of reasons for establishing the group and that these reasons fit with prospective member expectations and interests. Consider many of these attributes outlined above in defining your vision, goals, and strategies.

9 Robinson, R.J., and Van Osnabrugge, M., “Angel Investing: Matching Start- up Funds with Start-Up Companies” The Guidebook for Entrepreneurs, Individual Investors, and Venture Capitalists,” Jossey-Bass Inc. 2000 8 U n d e r stand the Risks: The advantages and potential re w a rds of angel investing can be desirable and financially satisfying. Despite the fact that this Guidebook is intended to support and guide the establishment of angel organizations that best suit a community and g roup-investment focus, one must also be cognizant of the downsides of angel investing. Angel investing is a high-risk game. Angels typically invest at an early stage of company development, when the future is on paper and in the founder’s dreams rather than in the bank. Angels also have some of the greatest potential for gain. R e g a rdless of the outcome, however, all angel investors must be willing and able to risk the loss of their entire investment. Return on investment can often take several years, if it happens at all. This seemingly negative discussion is not intended to deter your endeavors to establish an angel investment organization but rather to e n s u re a good foothold in re a l i t y.

9 B U I L D I N G T H E F R A M E W O R K ( C R E A T I N G Y O U R A N G E L G R O U P )

Now for the hard part: selecting the right As you go through the process of building your angel organizational, management, and membership structure organization, keep in mind the following almost for your group. You have many variables to consider, universal truisms: and it is important to establish some context and ⁄ Angel organizations are generally made up entirely framework in order to make informed choices. The of individuals, although some groups do have following decision-making matrix is intended to lead you entities such as venture funds and corporate sponsors to a comfortable and satisfactory answer for your as members. Entities typically have a different status, prospective members and community. such as associate members. One of the concerns for With each step, background points will be laid out, any angel group is that membership becomes mostly n u m e rous questions will be posed, pros and cons will be sponsors, service providers, and people who are given, and reality points will be identified. Of course, the interested in observing, but not investing. Steps ultimate test is acceptance by your members. This to avoid this migration in membership will be Guidebook also describes a few existing angel discussed later. o r ganizations with diff e rent stru c t u res that have ⁄ Angel organizations represent an active, rather than successful track re c o rds in attracting members and a passive, investment process. Members are making investments. In addition, several initial documents engaged in some way throughout the investment a re off e red in the appendices as examples of working process. Individuals seeking only passive investment documents for your organization and are intended to be opportunities should consider venture capital funds or useful for multiple organizational stru c t u r e s . a private equity manager.

⁄ The groups are made up of individuals with common i n t e re s t s , typically early-stage investments. Some g r oups, particularly in larger cities, may have an i n d u s t ry or market focus. This can influence potential membership by appealing to both those who would be attracted to your angel organization because of the p a rticular focus (but do not necessarily have any b a c k g round in the focused market) and those who you would be interested in joining your group because of their background and experience.

10 ⁄ Members have a mixture of experience and COMMUNITY ASSESSMENT backgrounds, not only in particular industries, but The first step in establishing an angel investment also in professional skills such as management, organization is to conduct a community assessment to finance, marketing, human resources, or research. better understand the nature of your investment Having members with different professional community and potential group members. Assessments backgrounds can be critical in conducting due must be made in an objective manner. The very fact that diligence on potential investment opportunities. you are reading this Guidebook indicates your interest in ⁄ With a few exceptions, angels prefer to invest establishing an angel organization. However, you must l o c a l l y. The reasons are several: from an interest in be conscious of community limitations or industry focus giving back to one’s community, to ease of perf o rm i n g that could hamper your attempt to establish a vibrant due diligence on the company, to interest in an ongoing angel group or that might limit the type of investments relationship with the company and management. available and, as a result, limit your membership.

⁄ As discussed previously, but worth repeating, a The following table gives you categories for evaluating successful angel group must have a champion or available data and general information in making your group of champions to ensure successful community assessment. No one community will have all establishment and operation. these attributes. Nor will you find the relevant data for all categories. The more valuable part of this exercise is ⁄ Group members value angel group dynamics, the actually conducting an objective analysis of your opportunity to learn from one another, and access to community to identify community strengths and superior deal flow. weaknesses in considering the viability of an angel ⁄ Last, but definitely not least, a primary reason that group. You may find that, although important attributes individuals become angel investors is a keen interest are missing, your community is strong in other areas or in capitalizing on high-return potentials. We have has the means to develop those missing aspects. You already discussed maintaining a strong hold on the may be able to complete the assessment with your local reality that angel investing is a high-risk proposition, entrepreneurial-support community and without paying and we must remind ourselves at each step that angel for an outside consultant. investors must be willing and able to lose their entire investment in the high-risk, adrenaline-pumping game of early-stage financing.

11 TA B L E 5 CATEGORY ASSESSMENT TOOLS OR INFORMATION ASK YOURSELF Community Assessment Questions and Process Potential angel Review census reports, home values, and number of 1. Does your community have a community successful industries (correlates to successfully exited strong presence of wealthy executives). It may also be informative to compare your individuals, especially those Does your community have region to other parts of your state to understand any trends who have made their money sufficient numbers of and stability in your region’s wealth population. through building their own accredited investors to successful company? form a viable group? Along with the need to have a solid population of potential members is the need to have members who can share their 2 . Does your community have a Is there a sufficient core experiences and expertise with new members. Angel number of public company of experienced investors investing is more sophisticated and involved than early c o r p o r ate he a d q u arters (whic h or other resources to help investment dollars coming from friends and family, who would suggest hig h - ne t - w o r t h with educating nascent typically invest out of affection and familiarity. Therefore, i nd i v iduals in senior positio n s ) ? angel investors? your members need the ability to have initial and ongoing 3. Does your community strongly education and training to improve potential investment support the arts and have a performance and long-term return, thus creating a successful number of endowed angel organization. organizations? (Also suggests high-net-worth individuals.)

Prevalent industries in Again, census information can help you better 1. How does your community region understand your community. Since angels generally invest compare in industry base, locally, you need to make a thorough assessment of your particularly high-tech or What established and regional industries to determine whether your particular biotech, with other developing industries are goals or interests for the angel group fit with your communities in your state and in your region? community. For instance, if you desire a high-tech focus for the nation in general? your angel group, but the vast majority of industries in your 2. Do these industries often region are agricultural or traditional manufacturing, you may create second- and third-tier have difficulties creating a successful angel group. entrepreneurs? Additionally, your regional industries should represent a good mix of markets that typically need start-up and further 3. Do your regional industries capital, with a healthy product or services market size often require start-up attractive for acquisition or IPO. financing, and are they able to obtain funding locally? 4. Are the companies represented by your regional industries appropriate for liquidity events such as an IPO or acquisition by a publicly traded company?

12 CATEGORY ASSESSMENT TOOLS OR INFORMATION ASK YOURSELF Entrepreneurial pool Assess the number of entrepreneurial companies in your 1 . Do you have a number of community, including the number of companies funded. y o u ng companies starting up in Does your community have Additionally, assess the ongoing likely sources of your area? (Your local busine s s an active entrepreneurial cutting-edge products or services, such as from leading t ra de public a t ion is often a environment? colleges in various disciplines. For instance, your good ind ic a t ion of the de g re e community may have a university, with colleges in the areas of ent re p re n e u r i al activity. ) of applied physics or biochemistry. 2. Is your community considered If there are no or few viable companies for investment and healthy and thriving, as well few sources of innovative products and marketing concepts, as attractive to entrepreneurs? it doesn’t make any difference how many high-net-worth 3. Does your community have individuals may live in your community — there won’t be centers of higher education, a de q u ate deal flow for the group. Add i t io n a l l y, your c o m mu n i t y particularly with graduate must be one that ge n e rally attracts ent re p re ne u r s because it programs in the areas of possesses many of the attributes described in this engineering, science, or math? community assessment. 4. Does your community have government-funded research centers?

Entrepreneurial M a ke an assessment of the number of start-up bu s i n e s s 1. Do you currently have, or infrastructure that services and pro g ra m s, as well as trade or industry would there be an interest in supports, educates, and a s s o c i a t i o n s , to get a better idea of entre p reneurial support conducting, regular fosters entrepreneurs in your region. Ad d i t i o n a l l y, make an assessment of state entrepreneurial investment and new businesses and local tax incentives and other legislation and economic forums, business-plan i n c e n t i ve pro g rams that support and promote growth. T h i s competitions, and similar Does your community have a nalysis may also give you a better unde r s t a n d i ng of the programs? entrepreneurial centers p re v a l e n ce of specific growth indu s t r ies in your commu n i t y. and entrepreneurial 2. Do your community Even if you have a solid pool of ent re p re n e u r s, the like l i hood of education programs and educational institutions have de v e l o p i n g successful businesses is diminishe d, or your associations? graduate-studies programs in c o m munity’s potent i al will not be met, without an active business, and do they support e nt re p re n e u r i al support system. entrepreneurial programs such as business-plan competitions?

13 CATEGORY ASSESSMENT TOOLS OR INFORMATION ASK YOURSELF Often, ex p e r ie n c e d , cashed-out ent re p re neurs will volunt e e r 3. Are there trade industry with ent re p re n e u r i al pro g ra ms as me n t o r s , pro g ram ma n a ge r s, associations in your or tra i ners as a way to give back to their community and community to support and stay involved. Investme nt fo r u m s can also be a terrific foster existing and new mechanism for hig h l i g ht i n g the cre a m - of - t he - c rop companie s companies, such as companies s e e k i n g fina nc i ng, since these fo r u m s typically have a related to software or s e l e c t ion committee to choose the companies to pre s e nt, as biotechnology? well as a coaching team for each selected company. 4. Are there non-profit T he political and business enviro n me n t must also be organizations in your c o n ducive to the growth of young companie s. Ac t i v e community with a specific E c o no m ic Developme n t Counc i l s, Chambers of Comme rc e, and mission to support and foster state legislators can be critically important and essent ia l . the growth of entrepreneurial Even the pre s e nce of a stro ng business journal can be an businesses, such as MIT Forum i n d icator of a he a l t hy enviro n me n t that fo s t e r s or Young Entrepreneurs e n t re p re n e u r s h i p . Organization (YEO)?

Support services/teams R ev i ew professional source guidebooks, and analyze the 1. Is there a good base of young number of firms and individual professionals that list and/or experienced talent for Does your community have services and skills re l e vant to early-stage companies. key roles in companies through a solid pool of Assess the talent pool for key team positions such as CFO, local graduate school experienced service C TO, or CSO by rev i ewing the presence of regional gra d u a t e programs, optioned-out high- providers and potential p r o g rams and professional association memberships and tech employees, successful senior management? by analyzing existing business human capital shortfa l l s . corporate managers or doctoral W i t hout exc e l l e n t prof e s s io n al support, brig h t and ambitio u s researchers? e nt r e p re neurs may struggle to create a solid company, placing 2. Does your community have your investme nt capital at greater risk. In add i t i o n , legal, accounting, marketing, i n v e s t me nt - g ra d e companies are not ma d e up of a sing l e and other services experienced i nd i v idual, and the pre s e n ce of key talent is critical to a in early-stage company s uccessful company. Any ent r e p re neur who believes he or she development and financing? can do it all is some o n e you want to shy away from, as no n e Do these service providers of us knows everything. Effective ent re p re neurs re c o g n i z e often speak on relevant topics t heir limitatio n s as well as their talent s. at various programs?

14 CATEGORY ASSESSMENT TOOLS OR INFORMATION ASK YOURSELF Follow-on funding M a ke an assessment of regional ve n t u re capital funds, 1. How many VC funds are m a t u re companies for potential partnership and funding, located in your community or Are there adequate local and banking re s o u r ces for debt and capital equipment general region? sources for sizable and financing. Ma ny ent r e p re neurs will need fund i ng past the later-stage financing? 2. Are there smaller VC funds that i n i t ial angel ro u nd. As a result, add i t i o n al fund i ng sourc e s may invest in earlier-stage b e c o me absolutely essent ial, if for no other reason than to companies? p rotect your angel investme nt. With the re c e nt dra ma t ic dro p in vent u re capital fina nc i ng, some angel org a n i z a t io ns have 3. Could your angel organization recognized the need to pro v ide fund i ng for companies past support any and all financing t he tra d i t i o n al early angel ro u nd. Ve nt u re capitalists are needs, and would this fit with f u nd i n g fewer and fewer early-stage deals and, as a re s u l t , member interests? a ngel investors must either step up to further fund an i n v e s t me nt or risk loss of their mo n e y. Of course, ma ny b u s i nesses re q u i r e fund i n g beyond the me a ns of most ange l o rg a n i z a t io n s, and available sources of subsequent fund i ng must be known. Angel org a n i z a t io ns that have conne c t io n s to, or ongo i n g re l a t io nships with, vent u re capital funds will have the advant a ge of potent ial follow-on fund i n g and better s c re e n i ng of early investme nts through re c i p r ocal re f e r ra l s f rom vent u re capitalists.

Keep in mind that any one community seldom has all of assessment is really intended to give you a better the attributes for supporting an angel organization, and understanding of the potential for success of your angel i n t e r p retation of facts and information should be g roup and, possibly, also determine the best investment balanced against your assessment of the re l a t i v e focus for your org a n i z a t i o n . i m p o rta nce of the various factors in your community. Now that you have completed your community Also, your prospective group may decide to lead your assessment and determined that your community has community in the development or expansion of cert a i n many of these attributes, it is time to move on to the activities, such as entre p reneurial support services or development of your angel organization. investment forums. There f o re, the community

15 SELECTING A STRUCTURE

A first step in setting up an angel group is determining ⁄ There is no one best model for angel groups. The the right organizational structure for your community angel organization “industry” is still in its infancy in and group members. The following matrix emphasizes many respects, and only limited research and the interdependency of your various choices or decisions evaluation have been conducted to date. As a result, related to the structuring and operation of an angel one cannot draw any conclusions about the group. Nearly every decision you make can affect superiority or success of one particular model. In fact, previous assumptions or decisions. As such, continue anecdotal evidence suggests that many models have to challenge your previous choices or decisions for fit been successful (if we can even agree on the measure and appropriateness with each step. Keep in mind of success). the following: ⁄ Form must always follow function. Do not choose

F I G U R E 1 a particular legal model or management structure and Decision Matrix then try to shoehorn your members into a model that does not fit their interests or investment orientation. Member-Managed vs. Manager-Managed Let your members’ interests and comfort levels guide your ultimate decisions.

⁄ Remember to keep your knees bent and challenge your previous decisions. As much as you would like the process of angel group development to be straightforward, your willingness to listen to input Investment Legal and adjust previous assumptions will bode well in Process Structure creating a successful organization.

Financial Membership Resources

16 DECISION STEPS This manager is not the same as a general manager of a v e n t u re capital fund, which has the authority and contro l M E M B E R - M A N A GED VERSUS MANAG E R - M A N A G E D over all investment decisions. Instead, an angel gro u p One of the fundamental decisions to make is whether your manager manages the gro u p ’s processes so that the o rganization will be managed by the members or by a members can focus on making investment decisions. p rofessional manager. By its very description, a member- Some of the pros and cons of these two basic managed (or member-led) organization re q u i res active structures are illustrated in Table 6. member involvement in nearly all aspects of operation. M e m b e r-led organizations usually hire administrative support to handle matters such as member communications, S T AT I S T I C S O N S TA F F I N G : In reviewing the meeting coordination, and database maintenance. results of the 2003 CVR survey of angel o rganizations, the majority (61%) of re s p o n d i n g In contrast, a manager-managed (or manager- l e d ) o rganizations had paid professional staff . o rganization employs the services of an individual(s) with I n t e r p retation of this percentage is difficult because experience and background in the investment pro c e s s o rganizations with paid management may be more and/or in the industry in which the angel org a n i z a t i o n likely to respond to a survey and because the intends to focus its investments. Ty p i c a l l y, a manager does i n t e r p retation of “paid manager” may diff e r much of the up-front work of vetting possible deals, between groups. However, if you take into conducting initial interviews with companies, coaching consideration the number of aff i rmative answers e n t re p reneurs for presentation to the angel gro u p , re g a rding the prevalence of paid management, handling member communications and relationships, and along with the presence of an executive dire c t o r even at times making recommendations on investments and/or administrative staff, most org a n i z a t i o n s and negotiating investments on behalf of the org a n i z a t i o n . TA B L E 6 a n s w e r ed in the aff i rmative. Again, the exact Structural Pros and Cons p e rcentage is a bit difficult to calculate because of the uncertainty of individual interpretation of MANAGER-LED MEMBER-LED t e rms and the rate of responses between Pros: Professional operation; screening and P ro s : G reater conne c t ion of members to group and o rganizations with stru c t u red management (even if investment activities conducted by a c t i v i t ies such as deal scre e n i ng, me m b e r only administrative support). As will be discussed experienced management; manager re c r u i t me nt, etc.; involveme nt pro v i des fo r handles member relationships h a nds-on educ a t i on for me m b e r s l a t e r, several factors will influence your decision on s t a ffing, including the org a n i z a t i o n ’s legal stru c t u re C o n s : O p e ra t i ng costs are hig her to cover Cons:Ability to maintain consistent volunteer p rof e s s io nal ma n a ge me nt inc o me, bene f i t s, commitment of members; potentially and budget (and how you finance your group). of f ice space, and adm i n i s t r ative support inconsistent operations

17 The following questions will help you make the many groups with actively participating members have fundamental choice between a member-led or manager- executive directors, and nearly all have some type of led organization. Keep in mind that even with member administrative support. A more detailed discussion of active participation in some or all duties and org a n i z a t i o n a l various group activities and duties is under “Operations” activities, a manager may still be quite appropriate, in this Guidebook. particularly with large groups (more than 75 members);

TA B L E 7 Member-Led versus Manager-Led Groups

QUESTIONS YOUR ANSWERS ( 1 or 2)*

1. Are members interested in reviewing all applications for presentation to the group, and do they have 1 or 2 the time to do so?

2. Are members interested in coaching companies for presentation to the group, and do they have the 1 or 2 time to do so?

3. Do members prefer to make all decisions on, and have direct involvement in, operational structure, 2 membership interaction, Web site content, public relations, and budget? 4. Will members be willing to contribute time on a regular basis to the executive and/or operational management of the group, including board activities, committee work, membership recruitment and 2 relations, deal screening, due diligence, and negotiation of investments? 5. Are members not willing to pay for professional staff, which can be a significant expense, in addition 2 to covering the operational costs? 6. Would members prefer to have responsibility for conducting many of the activities related to operating a successful angel organization, including member recruitment, meeting planning, deal sourcing, deal 2 screening, due diligence, and investment negotiation? Do members have the background and expertise to conduct these activities? 7. Would members prefer to hire administrative support staff to handle communications and meeting 1 or 2 planning, but leave other functions up to members? 8. Do you plan to operate your organization as an angel fund, with member-committed investments? If no, managers are not necessary, although even some organizations in which members make individual investment decisions have paid professional managers. Some member-determined investment groups will also have a sidecar fund, or a fund that invests alongside investments that may be made by the 1 or 2 angel organization. Again, this type of angel group would be well served by professional management. (see discussion) If yes, a manager-led organization is probably more appropriate because of the need to coordinate handling of investments. Additionally, a strong manager is typically a deciding factor for individuals considering membership and commitment of personal funds. 18 *1 = manager-led group most appropriate. 2 = member-led group most appropriate E x amples of manager-led and member-led When we talk about m e m b e r- l e d o rg a n i z a t i o n s , o r ganizations: Since this first decision point in your Tech Coast Angels in S o u t h e r n Californ i a group development process is so important, an example re p resents an effective operation. Volunteer members of each structure may be valuable to get a better manage the strategic as well as the day-to-day understanding of your choices. operations of Tech Coast Angels. Members are invited and encouraged to attend deal-screening meetings, An excellent example of a manager-led organization which occur twice a month, with member attendance is CommonAngels in Boston, Massachusetts averaging 40 to 60% at each screening meeting. All (www.commonangels.com). The organization has an intrinsic parts of the investment process are done by angel group of approximately 50 members, who make members, with support from part-time administrative individual investment decisions. In addition, or professional support of a deal-flow administrator CommonAngels has a sidecar investment fund (i.e., a and screening dire c t o r, who handle investment committed investment fund related to the angel mechanics such as assisting entre p reneurs in organization that invests through a separate completing applications, arranging meetings, etc. investment committee). An office manager and Members are experienced entre p ren eurs who have associates (often MBA students) support the been through it all, making them knowledgeable managing director. This is a structure that supports a investors and potential mentors. In fact, about two- larger, more diverse organization and provides the t h i rds of members have CEO experience. Tech Coast manager the ability to give attention to the big picture Angels has three chapters in San Diego, Orange as well as to details regarding member County and Los Angeles, and the entire Tech Coast communications and recruitment, deal screening, due Angel network shares deal flow, expanding the diligence, investment negotiation, and investment i n v e s t m e n t - o p p o r tunity pool for members. follow-up. Such a staff is an investment that needs to be aligned with your organizational needs and investment strategy. Much of the value and benefit of a manager-led organization comes from the combination of management skills and experience previously discussed, which CommonAngels most definitely possesses.

19 Finding the right manager: If a manager-led model d i re c t o r. Many groups may have only administrative staff fits your functional intentions and is aligned with to coordinate meetings and communications, and all member needs and interests, you should carefully other functions are left to members. As has been stated consider desired manager attributes. Cohesiveness b e f o re and will be repeated throughout this Guidebook, between the manager and your angel group can be the any of these models is perfectly acceptable and viable; single most important factor in the success of your the final choice depends entirely on your needs and organization. As such, consider the following member intere s t s . combination of skills:

⁄ Business expertise and savvy; L E G AL STRUCTURE ⁄ Financial intuition; Multiple legal structures work for both member-led and ⁄ Motivations parallel to those of the group; manager-led organizations. The preferred structure will ⁄ Domain or investment-focus expertise; again depend on your group’s desired complexity and ⁄ Organizational operation insight; level of member involvement, as well as appropriateness ⁄ Communication skills and diplomacy; for your community. Member familiarity with a particular ⁄ Leadership qualities; and structure and the angel investment group concept may ⁄ Process-management skills. be factors in legal-structure choice. The five currently Interestingly, these skills also are considered important in prevailing angel organization legal structures are: entrepreneurs, and should also be part of your due ⁄ Affiliation without Formal Structure : A loosely diligence review of management. a ffiliated organization is appropriate for member- l e d Remember that a manager is more than administrative g r oups, particularly those with a smaller number of s u p p o rt. The manager should be a leader, coord i n a t o r, members and/or early in their operation. Inform a l d e c i s i o n - m a k e r, spokesperson, and den mother for your g r oups usually work well up to around 15 members, angel group. Many angel groups prefer to retain these when more stru c t u r e is needed for basic operations. roles in its members and may choose to employ an P a r t-time administrative staff may be helpful to handle executive dire c t o r, who typically handles member matters such as member communications and meeting relationships, communications and other operational logistics. Generally, these groups have regular meetings, matters, but plays a minimal role in the investment with any and all investment decisions made on an p rocess. Certainly some of the skills listed, particularly the individual basis. Members usually are active in all second half, would be valuable skills for an executive aspects of the group, from screening business plans to membership re c ru i t m e n t .

20 Obtaining financial support for informal groups can be A F F I L I AT I O N S M AY B E B E S T F O R : challenging, depending on the desired level of sophistication. Costs can include items such as ⁄ Small groups (fewer than 15) member communications and information ⁄ Getting started, before membership is fully management, meetings, and due diligence. Typically, identified and uncertain as to group desire s cost coverage must come from the members, with the and needs advantage that costs are usually relatively low because of the lack of formal structure and limited ⁄ Each member desires to remain independent in membership. No particular documentation is all aspects of investment pro c e s s necessary, but the group may wish to have some agreement or code of conduct between members requiring that they respect one another’s confidences. Additionally, decisions regarding membership should ⁄ N o n p r ofit Corpora t i o n : Many organizations that be made through group consensus to maintain the start out as informal groups to test member interest desired culture and intimacy of the group. will migrate toward a more formal structure. As discussed above, this is particularly true when the I n f o r mal groups work best with a small number of group grows and adds members. The nonprofit members. When membership grows, stru c t u re corporate structure allows for easy establishment of becomes a necessity to handle group issues and formal decision-making processes for handling group operations. Affiliations work well as a first step when dynamics and operations through a governing board. i n t rod ucing the concept of organized angel investing The nonprofit structure, as with other formal to a community. Individuals may have tre p i d a t i o n s structures discussed below, facilitates the about plunging into a highly stru c t u red org a n i z a t i o n establishment of banking accounts and the hiring of or actual angel fund, and they may prefer to build a staff and enhances the group’s ability to enter into t r ust level before developing a more form a l contractual arrangements. o r ganization. Similarly, some investors are fierc e l y independent and private about their investment decisions, and while they appreciate and enjoy gro u p camaraderie, they consider the actual investment choice and process to be their own business. For these investors, an affiliation is a good choice.

21 The term “nonprofit” generally refers to a corporation 501(c)(6) organizations are not tax deductible. This brief formed under a state nonprofit corporation statute. discussion of tax-exempt organizations should not be Typically, nonprofit organizations are either mutual- i n t e r p r eted as minimizing the considerable re q u i re m e n t s benefit entities, such as private clubs, which exist for to qualify for a tax-exempt status. As with development the benefit of their members, or public-benefit of any organization, one should consult a pro f e s s i o n a l entities, such as community food banks, which exist skilled in the are a . for the public benefit. States generally have one As evidenced by the statistics outlined below, nonpro f i t statute that governs for-profit corporations and o rganizations have been a frequent choice for angel another that governs nonprofits. Thus, state law g roups. To obtain tax-exempt status, an org a n i z a t i o n determines the nature of the entity to be formed and must fulfill tax-code re q u i rements for purpose and governs its day-to-day operations. s t r u c t u re and then remain consistent with them to A “tax-exempt” organization is one that the Intern a l maintain the status. These re q u i rements can be Revenue Service (IRS) has recognized as meeting cert a i n restrictive for some groups, particularly those intending tax-law re q u i rements for exemption from federal to invest through the group organizational stru c t u re . income tax. Most tax-exempt organizations are This may also be an unworkable stru c t u re if you desire n o n p r ofit corporations or charitable trusts. The fact that to compensate the group manager or others through a an organization is formed as a nonprofit corporation p o rtion of the investment, sometimes called the under state law does not make it tax exempt. Wi t h “ c a rry. ” 1 0 On the other hand, tax-exempt status is well minor exceptions, an organization must file an suited for groups in which individual members make application for federal tax-exempt status with the IRS their own investments and the angel group exists to and receive a “determination letter” granting the p romote the gro u p ’s purpose or to educate its exemption. The application is made on IRS Form 1023 members and others on angel investing. (for Section 501(c)(3) organizations) or Form 1024 (for The Sierra Angels is an excellent example of a other organizations). The Internal Revenue Code grants 501(c)(6) organization. Soon after launching the angel an exemption from federal income tax to more than 25 group in the Lake Tahoe area of Nevada, the d i ff e rent categories of organizations, with the most members discovered a lack of regional management p r evalent sections for angel organizations being talent and skilled labor. In addition, there were few 501(c)(3) or 501(c)(6), educational pursuits or trade links between the business, education, and research associations, re s p e c t i v e l y. Donations to 501(c)(3) communities, and limited access to venture capital o rganizations are tax deductible, while donations to

10 You may still be able to make this work later if all investments are made 22 (and carry given) through a structure separate from the operational organization. As mentioned, consult a professional for advice on structure. and lending sources. As a result of these deficiencies, clear processes and systems (some of which will be Sierra Angels expanded their charter in order to play a discussed later in sections about deal flow and key role in the economic development of the region. investment), supporting an emerging culture and Today, Sierra Angels is definitively involved in many building traditions, and educating and communicating aspects of educational development and economic both within the group and in the marketplace, AHI diversification in Nevada. These educational activities has become an innovative, responsive, cohesive, and provided the ability to file for and receive a 501(c)(6) respected angel organization. All investments are tax-exempt status. made through separate one-time investment vehicles, which, in AHI’s case, is a new LLC for each investment Examples of member activities include: participation in (as opposed to individual participants writing checks the drafting of the master plan for University and directly to the company). Each investment then has a Community College System of Nevada; participation designated portfolio monitor — either a staff person in the development of the University of Nevada-Reno or a group member — to observe the investment and Strategic Plan; active members on the advisory boards report back to the group. for the Colleges of Engineering and of Business Administration for the University of Nevada; Nevada Center for Entrepreneurship and Technology (a NON-PROFIT ANGEL GROUPS MAY BE BEST FOR: public/private corp.); Golden Capital Network; and ⁄ Nearly any group other than an angel trustees for the Sierra Nevada College, helping the investment fund in which members share college become a distinctive, focused, liberal arts in investment profits and losses through the college with prominent majors in entrepreneurship, fund structure computer science, entertainment technology, and environmental science and policy. ⁄ Even with angel funds, group operations may be supported through a non-profit stru c t u re , Another excellent example is Angel Healthcare and investments can be made through separate Investors, LLC, in Boston which, like so many other legal stru c t u res such one or more LLCs angel groups grew out of the founders’ common professional background and their mutual interest participating in early-stage investment opportunities, through a community of collegial, well-connected and talented health-care professionals with a desire for yield of economic and social benefits. By developing

23 ⁄ Limited Liability Company : LLCs are emerging as a The Washington Dinner Club (Washington, DC) popular legal stru c t u re for angel organizations. LLCs are demonstrates the success of a manager-led limited m o re complex in operation, with capital accounts and liability company (LLC). The Dinner Club was formed p r ofit/loss distributions, but they do provide a number by two regional investors who successfully established of benefits. Individuals can be members of the LLC, three such groups. This angel group structure allowed with one or more managing members. Officers can be for two classes of membership interest — one for elected just as with a traditional corporation. LLCs can individual investors with one vote per member and a have a board (sometimes called a “Board of second class for institutional investors, which had no Managers”), which functions much like a corporate voting rights. In the third Dinner Club, membership b o a r d of directors and serves many of the same was capped at 75 individuals and 10 institutional purposes of operational oversight, strategic planning, members, with a minimum of 30 individual and approval of certain organizational matters. The LLC memberships in order to activate the LLC. Individual s t ru c t u re provides considerable flexibility in membership members were required to make an initial capital (both individuals and entities can be members) and has commitment of $50,000, with a total of $150,000 the possible benefit of being taxed as a part n e r s h i p . investment commitment over the LLC term. The stru c t u re works well for both manager-led and Institutional investors were required to make a total m e m b e r-led organizations, with statistics showing a fair investment commitment of $500,000 in similar balance between these two management stru c t u re s . increments. The Club had an operating budget LLCs are particularly well suited for angel groups that (roughly calculated at 2 to 3% of total subscribed re q u i re an up-front commitment of capital fro m capital) for its monthly dinner meetings, support members and then make investments through the fund services for meetings and due diligence, accounting, (as opposed to individual investments). A few angel and other operational expenses. Managers received a g r oups create separate LLCs for each investment, with management fee from the operating budget and a the LLC members being those members of the angel 15% carried interest from any portfolio gains, on a g r oup choosing to participate in that investment. deal-by-deal basis. The managers were responsible for the day-to-day operations of the Club, including member communications, administrative matters, and L L C S T R U C T U R E S A R E B E S T F O R: deal flow. Members participated to varying degrees in ⁄ Angel investment funds, although the stru c t u re can be used for any angel due diligence, investment terms negotiations, and g roup. As noted above, LLCs have a more complicated tax stru c t u re with a post-investment relationships. Reflective of angel p a rtnership taxation stru c t u re, so if your group intends to have individual groups, all investments were made only upon members make their own investments in portfolio companies (i.e., no pooled membership approval. or combined funds for investment), a simpler stru c t u re such as a non-pro f i t corporation may be best 24 ⁄ C o r p o r ation (Fo r - P r ofit) and Subchapter ⁄ Limited (Liability) Pa r t n e r s h i p : Venture capital S Corpora t i o n : A traditional corporation is the legal funds are now almost universally structured as LPs or structure of most publicly traded companies, with LLPs. Investment decisions are made by the general shareholders, boards of directors, and corporate partners, with the limited partners taking a passive taxation. The 2003 CVR angel group survey shows role, which is legally mandated for limited-liability that approximately 9% of the responding angel status. Because angel groups are made up of active organizations have a traditional corporate structure. A investors, this legal structure is seldom seen and may corporation can work well as the parent or holding be present only in limited side funds (funds that company for more sophisticated angel organizations operate alongside an angel group as an independent desiring a different entity for management functions investment vehicle). that are separate from the investment vehicle. One possible use of an LP is when management is Subchapter S corporations provide a group with all compensated through a percentage of each the functional and organizational attributes of a investment. For those groups that have a dedicated corporation, but with partnership tax treatment. fund with long-term compensation to professional However, S Corporations are less flexible than LLCs. In staff (i.e., “carry”) as well as individual angels contrast to LLCs, S Corporations may have only participating directly in investment opportunities, an individuals as shareholders, and only one class of LP can serve as an intermediate vehicle between the stock may be issued. These limitations can create fund and the manager to hold the carry. This problems for members wishing to run their investment intermediary gives the manager several advantages: portfolio through a corporation or some other legal ⁄ Employees receive the legal benefit of a corporate organization, or if you desire to have different classes shield; of ownership, such as a different class for each investment, which will be made up of different ⁄ The manager can change staff over time without individual members for each investment. As a result of the complexity of swapping general partners or the these limitations, this structure is seldom chosen by manager itself; and angel organizations. ⁄ N o n - a c c redited investor employees can receive part of the carry by being members of the LP. Ty p i c a l l y they cannot be direct participants in the fund itself without damaging its status as an accredited investor.

25 ⁄ Affiliation without formal structure, which is not S T AT I S T I C S : Looking at existing angel organizations sheds light on proven recommended for groups with more than 15 members, models. According to the 2003 CVR angel group survey: due to the necessity for organizational structure, ⁄ 44% of responding groups were nonprofit and/or 501(c) organizations operation, and governance with larger groups.

⁄ 38% were limited liability corporations ⁄ L L C can be used for all intended operational s t ru c t u r e s . LLCs provide the protection of a corporation and are ⁄ 9% were corporations taxed as a partnership. Member capital accounts and ⁄ 7% were informal groups or affiliations p rofit-and-loss allocations can be confusing, so consult a professional. Because of these various accounting ⁄ General and limited partnerships were not favored legal structures and tax aspects of LLCs, some groups have used the non-profit structure (whether or not federally tax exempt) as a simpler, straightforward structure with Questions for Choosing Your Legal Structure : g o v e rna nce attributes similar to a standard corporation. The following questions will help you choose a This latter point of avoiding a complex legal structure legal structure for your organization. Before is particularly true for member-led groups. making a final decision, however, you should ⁄ As discussed above, non-profit corporations can be obtain professional advice on this issue. a good choice for groups with individual member Q. Do you intend to require member investment investments. A non-profit would not be appropriate commitments to create a pooled fund? for a fund or group that intends to invest through the group legal entity and/or distribute returns through If yes, an LLC structure would work well as the the entity, since non-p rofits cannot provide share h o l d e r operational structure as well as investment vehicle. benefits. Whether or not your group files for tax- If no, almost any other structure will work, depending exempt status is another level of decision-making that on other factors such as the desire for greater involves making real, conscious choices about group organization (therefore, not a simple affiliation) and the focus and mission. anticipated level of governance of group activities. ⁄ C corporations or Subchapter S corporations can Therefore, the choices can be: also be used but do not provide any special benefit outside the other structures.

26 Q. Would members prefer little or no structure, and Table 8, on the following page, gives a summary do you intend to keep membership to a small, comparison of the various legal structures. intimate group?

If yes, a simple affiliation can be appropriate.

If no, consider other priorities for your group, such as:

⁄ A need or desire to have a tax-exempt structure to avoid any tax issues, which suggests a 501(c) structure, assuming the organization’s operational purpose and other relevant factors align with requirements for obtaining and maintaining tax- exempt status.

⁄ Members’ desire to have considerable input on operational matters. Along with suggesting a member- led rather than a manager-led organization, significant member involvement can be accomplished thro u g h any of these legal stru c t u res. An L L C or n o n - p ro f i t c o r p o r a t i o n can provide for member involvement, although typically a smaller set of individuals act as the managing members or board of directors, re s p e c t i v e l y. As noted above, L L C s work well for manager- l e d funds, even with group members desiring active involvement in group management or govern a n c e , since the manager can be designated as the managing member or given other designated authority, with angel investors making up the board of managers.

27 TA B L E 8 Legal Structure Comparison

FACTOR LIMITED LIABILITY NON-PROFIT 5 0 1 ( c) TA X - E X E M P T C CORPORATION S CORPORATION LIMITED COMPANY (LLC) CORPORATION O R GA N I Z AT I O N (STANDARD) PARTNERSHIP TYPICAL Investment fund Member investments Member investments Member investments Member investme n t s Rarely used, typical investment model (can be used for (can be a separate (can be a separate (can also be the (could also be used VC structure member-determined or parent entity for or parent entity for management vehicle as an investme n t investment groups) group operational group operational with a side fund for f u nd, but limited to purposes, with a purposes, with a group investment) o ne class of stock, separate entity as separate entity as a n d only ind i v i dua l s an investment fund) an investment fund) may be share ho l d e r s ) Liability Limited Limited Limited Limited Limited Limited for limited partners, liability for general partners Governance Board of Managers B o a rd of Tr u s t e e s / Board of Trustees Board of Directors Board of Directors General partners D i r e c t o r s , de p e nd i ng on whe t her a public - b e nefit or mu t ua l - b e nefit org a n i z a t i o n Taxation As a partnership At corporate level No tax At corporate level or As a partnership As a partnership (as non-profit consequences and do u b l e - t a xed on corporations cannot no shareholders d i v ide nd distributio n have shareholders) Membership No limit on me m b e r No limit on me m b e r Same as non-profit Members may also be Only ind i v i duals ma y O w n ership is by numbers ge n e ra l l y. If numbers; no corporation s h a re h o l de r s, and, as be share h o l de r s, and ge ne r al and limited a fund, the opera t i ng s h a re ho l ders in no n - s uch, this struc t u re only one class of p a r t ne r s, the latter do c u me nts of t e n p rofit, the re fo re no t can be used as an stock is permitted b e i ng partia l l y have a ma x i mu m a p p ro p r i ate as an i n v e s t me nt vehic l e de f i ned by the i r number of me m b e r s i n v e s t me n t vehic l e (but be aware of no n - i n v o l v e m e nt in re l a t i ng to fund size (look to LLC or fo r - do u b l e - t a x a t io n ma na ge m e nt and p rofit C corpora t i o n i s s u e s ) o p e r a t io n s, thus no t if de s i re gro u p ge ne r ally appro p r ia t e i n v e s t me n t struc t u re ) for angel gro u p s

28 INVESTMENT STRUCTURE Even with group investments, most organizations allow members to make additional, separate investments in Angel group investments can be broken down into companies chosen for group investment, and certainly essentially two forms: anyone is entitled to make any investment in a company not chosen for group investment. G r oup Investment

⁄ Pooled funds with each investment: Some groups Individual Inve s t m e n t combine the financial power of individual investments ⁄ Based on group due diligence, individuals can into a group or pooled investment, giving the group then decide if a company fits their planned investment collective negotiation power. criteria and portfolio. As with a pooled fund, individual ⁄ Pledged or committed funds are invested by investors can combine their funds into a single group decision. Upon majority group affirmative investment vehicle, such as an LLC (assuming that decision, the group invests a defined amount. The e v e ryo ne is an accredited investor). The basic diff e re n c e investment amount can be decided by vote of between this approach and the pooled funds appro a c h committed and pledged fund members or by is the understood intent and the gro u p ’s defined individual members for pledged funds. Additionally, investment process. In other words, with a pooled fund, the manager can recommend an appropriate g r oup members understand that investments will be investment amount based on company analysis. No made through a group decision process, with pooled or respondents to the 2003 CVR survey required combined funds invested into the portfolio company. unanimous affirmative group vote for investment. On the other hand, even with group due diligence, an angel group set up to allow individual investment D E F I N I T I O N S : “Pooled funds” refers to a process in which individual decisions does not have the assumption of collective members make their own investment decision, and then the group combines investment decision or investment, but rather each all member dollars into a single investment. angel investor makes their own decision for investment. F rom this individual decision, based on group (or “Pledged funds” refers to member commitment of a certain dollar amount, individual) due diligence, the group can always decide but the money is not transferred to the angel organization until needed for to combine their investment amount into a single investment. The amount invested can be a group decision of an investment investment such as through an LLC. amount, or a group may allow individuals to decide personal investment amounts, with the latter having an annual investment requirement.

“Committed funds” require that members place their investment amount in the fund upon membership acceptance, or in staged and timed quantities for cost coverage and investment purposes. 29 ⁄ Based on individual assessment, which typically One must consider numerous factors when determining relates to fairly informal groups, or a circumstance the nature and attributes of membership: where only one member is interested in the company. S e l e c t i o n : ⁄ Side-fund investment with individual additional inve s t m e n t s can work well, with the ⁄ Membership Numbers: side fund conducting much of the due diligence and sometimes leading the investment. ⁄ Depending on your angel group’s goals and purpose, you may wish to limit the number of members. For instance, if the model that most D E T E R M I N A TION OF MEMBERSHIP ideally fits your interests and those of your members When asked about having established membership is to establish an angel investment fund with up- criteria in the 2003 CVR angel group survey, all front fund commitment, you will want to set a responding groups answered in the affirmative. Nearly defined size for the fund and a minimum all angel organizations require that members be investment per angel investor to give potential accredited investors. As discussed earlier in this investors/members an understanding of the Guidebook, companies prefer to present solely to intended fund size. accredited investors to allow for qualification under ⁄ On the other hand, informal angel groups often regulatory exemptions from certain registration, limit membership to maintain a certain culture or to information, and other requirements of federal and state assure the continued cohesiveness of the group. securities laws. As a result, companies prefer to avoid non-accredited investors (for whom at least the information-disclosure requirements would apply). Therefore, angel organizations with all (or essentially all) accredited investors are more likely to attract strong investment opportunities.

30 ⁄ Be sure that membership-recruitment objectives and S T AT I S T I C S : Number of members by organizational structure — Looking at requirements are clearly communicated to all the statistics from the 2003 CVR survey, we see various legal or organizational prospective members. Member applications should structures with the following membership numbers: be reviewed, and new members should receive ⁄ Informal Affiliations: Typically not more than 20 introductory materials clearly stating the group’s organizational philosophy, goals, objectives, rules ⁄ Non-profits: Groups range from 25 to 125 in members of conduct, and code of ethics. ⁄ LLCs (typically funds): Many of the funds cap membership at 50 or 75 ⁄ Membership Tiers: ⁄ Individual members are a given, but some gro u p s o ffer other tiers of membership. Affiliate membership ⁄ Membership by Invitation Only: may be off e red to venture capital fund re p re s e n t a t i v e s . ⁄ F o r mal groups usually have a membership The VC fund could have a range of member rights, committee, with responsibility for member f rom attendance at meetings only to full part i c i p a t i o n re c ruitment and selection and for ongoing member rights in any deal. Whether or not a VC fund or relations. Most groups appear to re q u i re a curre n t sponsor is a voting member of your angel group is an m e m b e r ’s recommendation or sponsorship for a individual choice; just be careful that, if voting rights n e w, potential member. With few exceptions, a re given, control is not inadvertently shifted away angel groups re q u i re members to complete a f rom the angel members. The advantage of including membership application, which typically contains a VC funds at some level of membership is the statement re g a rding accredited-investor status and re c i p r ocal value of sharing deals. This same point can recognition of the org a n i z a t i o n ’s code of c reate a disadvantage for some, with the fear that the conduct/ethics. Most groups re q u i re annual VC will scoop the good deals out from under the renewal of membership, with the re a ff i rma tion of g roup. These concerns can be alleviated to some a c c red ited-investor status and a pledge to gro u p extent by requiring VC funds to share deals in order to philosophy and conduct re q u i re m e n t s . be members. Similar to VCs are investment bankers and bro k e r-dealers, although angel groups must be m o re careful with their accredited-investor status. The same criteria should be used for these entities, with the additional re q u i rement of no meeting solicitation (see discussion below on sponsorship).

31 ⁄ Depending on group financial re s o u rces, sponsor ⁄ Dues and/or Investment Pledge: memberships may be attractive. The next section of The expenses of running an angel organization must this Guidebook will discuss costs and the options be covered somehow (see the list of possible costs for coverage, but for purposes of the discussion, below). Expecting members to continually donate assume that you have decided to have some costs materials, cover mailing expenses, or volunteer c o v e red by outside entities. Professional serv i c e administrative and other support services is unrealistic, o rganizations, such as law and accounting firm s , unprofessional, and short lived. Members should will fund angel organizations or events related to expect to pay dues to cover costs. The discussion in early-stage companies, wealth management, and the Group Operations section, which begins on page other areas of their market focus. If an entity 40, as well as Appendix 5, provides a sample budget a g rees to sponsor an organization or event, fairn e s s calculation for estimation of costs. Also discussed in and good business dictate that some benefit should Group Operations are various sources of funding, be provided for the pledge, although gro u p including a percentage of pledged funds to cover membership is not typically a benefit. The rub is management and operational costs for angel funds. how to provide these benefits without your gro u p meetings turning into a networking event for ⁄ Desired Culture: s e r vice providers rather than focusing on deal Groups often limit membership, if for no other reason s c reening and investment analysis. Some than to maintain a desired culture. Intimacy and mechanisms to assure meeting focus include frankness of discussion may be overriding goals that limiting the number of sponsors and sponsor naturally limit the number of members. On the other re p res entatives at each meeting and controlling any hand, many groups find advantages in large numbers and all membership lists and corre s p o n d e n c e . because of the resources available through better Benefits that may be provided to attract sponsors potential deal flow, the opportunity to make larger include introduction of guest speakers, opport u n i t y deals, and a greater pool of resources in membership to conduct member training sessions, sponsorship skills and background. of the angel gro u p ’s Web site, and placement of marketing materials and spiffs at meetings.

32 Never underestimate the value of defining your Q. What will be the criteria for membership, other than culture. People are attracted to a group not only the requirement that members be accredited because of tangible member benefits, but also investors? because of group goals and objectives, existing ⁄ Other membership requirements could be: members, group reputation, and group dynamics. A well-understood membership-selection process helps ⁄ Particular expertise, such as marketing or finance to maintain the group’s desired culture and a ⁄ Specific background in an industry or market commitment to the desired group personality. ⁄ Geographic ⁄ High net worth Membership Questions: ⁄ Gender ⁄ Investment commitment The following questions may help you better art i c u l a t e ⁄ Previous investment experience your membership stru c t u re and membership qualifications. ⁄ Time commitment

Q. Will the group have a particular investment focus, Q. Should there be different tiers of members (e.g., such as software, telecommunications, biotech, or individuals, VCs, sponsors)? consumer products? Will you seek members with ⁄ If yes, consider: specific backgrounds or expertise? ⁄ Different membership fees for VCs and other ⁄ If yes, your membership process should include a entities, usually higher than individual fees clear definition of group investment focus, and your ⁄ D i ff e rent fee for members outside your re g i o n a l membership recruitment should focus on individuals a rea (if accepting such members) and providing for with experience in the relevant industry and interest their attendance at some percentage of total annual in such investment directive. meetings (with corresponding reduction in fee) You may wish to double-check your community ⁄ Sponsors are generally not provided membership assessment to ensure that your community has but rather allowed attendance at meetings for a adequate interest and entrepreneurial base for a defined number of representatives focused group; otherwise, you will need to consider ⁄ Membership-fee amount depends on costs and a broader geographic investment range. other sources of revenue, as well as membership- fee tolerance

33 Q. Will there be a limitation on membership numbers? ⁄ Some cultural attributes to consider are: Keep in mind that the larger the group, the greater the associated expenses in terms of communications, ⁄ Intimacy need for formality of operations and structure, ⁄ Learning environment meeting logistics, etc. ⁄ Social ⁄ Networking ⁄ Will your angel group be a fund? ⁄ Experience sharing Pure investment ⁄ If so, your membership will be capped by the ⁄ Safe environment fund amount ⁄ Setting cultural aspirations can be easy but ⁄ Do you desire a small, intimate group without any ⁄ preserving more difficult. This can be accomplished formal structure? through: ⁄ If so, your group should be no more than 15 Clear articulation of culture in membership members (as a guide) to prevent the necessity of ⁄ documents and on group Web site legal formalities and administrative support that Regular reminder to members comes with larger groups ⁄ Consideration of desired culture when considering ⁄ If not, your size depends on your ultimate group ⁄ other types of membership such as sponsors or VCs mission and goals (notwithstanding fund member Design meeting agenda to meet cultural goals limitations) ⁄ ⁄ Membership limitation may also be important Q. What will be the cultural atmosphere of your Q. Are members willing to invest considerable time in group? What are your priorities? group governance, management, and operations? ⁄ E v e ryone desires some cultural identification for their If no, be sure you have considered a manager-led g roup. The group champion and founding board ⁄ structure should spend time discussing and articulating values ⁄ If yes, and depending on the extent of member willingness to volunteer, a member-led structure can be quite effective with administrative support and/or an executive director

34 S T AT I S T I C S : Membership numbers from the 2003 CVR survey show: S T AT I S T I C S : Looking again at the results of the 2003 CVR angel organization survey, we find ⁄ No limit on membership: 66% in response to a question on cost coverage: ⁄ Average size: 50 members ⁄ 67% identified membership dues as one of ⁄ Of those limiting membership: the primary sources of group funding. Of these groups, 57% identified other sources of ⁄ 53% are LLCs (which are limited if fund) funding, including percentage of committed ⁄ 20% are informal affiliations capital (mostly LLCs) and events or (which limit for desired cultural or administrative reasons) sponsorships (mostly nonprofits). ⁄ 13% are non-profits ⁄ 13% are corporations ⁄ 31% listed percentage of committed capital as a source of funding. All but one of these were LLCs, which is logical, since the LLC legal s t ru c t u re predominates angel investment funds.

⁄ 33% identified sponsorships, with only two FINANCIAL RE SOURCES: FUNDING YO U R organizations listing this as their sole source ANGEL ORGA N I Z A T I O N of financial support.

As with many organizations, funding an angel group ⁄ 20% listed events as a source of financing, but adequately can be challenging at best. Asking members none listed events as their sole source. The for group financial support through dues, a percentage majority (63%) of organizations listing of committed capital, a percentage of the carry, or a sponsors and/or events as sources of financing combination of these sources is a necessary evil. w e re nonprofit or 501(c) organizations (gro u p s Rightfully so, members expect value in return, in the listing both sources were counted only once). form of well-organized meetings, good deal flow, and a 28% indicated that costs were nominal. satisfying focus on investing. ⁄

35 So what are the attributes or parameters of these ⁄ Pe rce ntage of committed capital or pooled funds: various funding sources? ⁄ Angel funds in which members are required to ⁄ M e m b e r ship dues: If membership dues will be your commit capital up front typically have a portion of sole source of funding, they must be set at an amount the committed capital allocated to cover operational s u fficient to cover all contingent costs and allow for a costs. Along with the 2% to 3% to cover modest re s e rve. Annual membership renewal and dues management costs, staff can be compensated and payments will help with budgeting. Also, rather than incentived to maximize investment value and return having rolling renewal dates for members, choose a by directing a percentage of the deal (referred to as fiscal-year stru c t u re and have annual renewals some the “carry”) to them. Often staff members are not time before the start of your next fiscal year. For accredited investors, which can pose a potential members joining mid-year, you can offer a perc e n t a g e problem if the carry is given directly to staff. The discount on dues to encourage membership. discussion under Legal Structure, on limited partnerships, offers one structural alternative to The “Angel Equity Survey” created and managed by resolve this problem. Your lawyer can recommend EMME Consulting found, in its Q1 2003 Pre l i m i n a ry other solutions, including a possible LLC. Results, a significant variation in membership fees which may be explained by the disparity of services off e red by ⁄ Another form of “percentage of committed capital” angel groups. This variety of services included: is to allocate a portion of the gro u p ’s specific investment commitment to cover operational costs ⁄ Facilitation (meeting space and administration) related to investments. This can be a bit complicated, ⁄ Meeting meals but arguably fairly allocates expenses. The mechanics ⁄ Proposal funneling would be that after individual members make their ⁄ Introduction (introducing entrepreneurs to investors) contribution to the group investment, but before the ⁄ Proposal screening actual investment is made, a percentage of the ⁄ Due diligence research investment amount is carved out to cover the re l a t e d ⁄ Standard term sheets costs. Problems that can arise from this appro a c h ⁄ Legal services that must be considered include: ⁄ Investment/valuation analysis ⁄ The possible need for a separate legal entity for each investment, since members will be different for each investment (although some groups already successfully use this model, which will be further discussed under Investment Process).

36 ⁄ No one invests after expenses are incurred, and s e rvices. Some groups have gone to the extent to include they must be covered. in their rules of conduct a prohibition against members actively soliciting other members during meetings. ⁄ D i s a g reement as to the value and time contributed by staff and, even possibly, other members. This ⁄ E v ents and pro g r a m s . Investment and educational issue is arising with more frequency as member- l e d forums can be an effective mechanism for introducing g roups struggle with how to encourage members promising new companies and educating the public. to volunteer for the time-consuming task of due Any event is complex and time consuming and should diligence. A possible solution is to offer these be approached with this recognition. These events are members some form of compensation. Since cash well suited to nonprofit/tax-exempt organizations. For compensation is usually not appropriate, offering a instance, fulfillment of a tax-exempt purpose of p e rcentage of the group investment or warrants (if education can be met through a variety of vehicles, the company is amenable) may be a good including a public educational program. Some solution, but this takes advance planning and nonprofit organizations use investment forums as a g roup agre e m e n t . source of group funding, which can work particularly well in a community with unmet needs for matching ⁄ S p o n s o r s h i p s : Sponsors can be an effective and investors and entrepreneurs or in which the angel significant source of funding, as long as the gro u p organization has a strong presence to attract e n s u res that member meetings maintain their focus on investors, presenting companies, and sponsors. member needs. It is important to control the number of sponsors and re p resentatives. The G roup Operations ⁄ C o m p a n y Fees: Many organizations charge selected section contains suggestions for sponsorship parameters companies for the right to present at a member meeting. and benefits. Remember, however, that service pro v i d e r s Most are willing to pay a reasonable amount for the will not generally sponsor an angel organization or any privilege of exposure to a group of potential investors. other group/event just to be good citizens. Budgets are H o w e v e r, the amount should not be so large as to drive often tight, and sponsors need to have some re t u r n on good companies away or raise possible issues of bro k e r- their investment for sponsorship dollars. dealer status for the angel group. Some groups also c h a rge a small amount to all applicants. This amount One caveat: many professionals are also accre d i t e d helps cover the administrative activities associated with investors and would qualify for membership. An individual’s p rocessing the application. A slightly higher amount p rofessional background should not prevent membership; might be supportable for circumstances in which all o t h e rwise, your membership numbers may be limited. applications are made available to members through the H o w e v e r, all members should understand that meetings are g roup Web site, thus increasing company exposure even for evaluating investment opportunities and not for selling if not selected for pre s e n t a t i o n .

37 SUMMARY OF BUILDING THE FRAMEWO R K

We hope that this first part of the Guidebook has given As a summary of key points in Building the Famework, you considerable food for thought and valuable guidance the following table offers an alternative view of various in the establishment of your own angel org a n i z a t i o n . choices in the decision process: Although not mentioned before because it seems obvious to the author, do not forget the most important re a s o n for devoting thousands of volunteer hours to creating an angel org a n i z a t i o n — the journey and resulting successful g roup are re w a rding, personally satisfying, and fun.

TA B L E 9 : Creating Your Angel Group Summary

ORGANIZATION ORGANIZATION GROUP DYNAMICS ADMINISTRATIVE AND MEMBERSHIP REQUIREMENTS TYPE STRUCTURE OPTIONS OTHER SUPPORT Member-Led 1. Informal organization with Generally a volunteer Adm i n i s t r ative support ge n e ra l l y S o u rces of fina nc ial support will Groups little structure: Group of organization, with members is ne e ded to coord i nate mu l t i p l e d i ctate membership dues and the individuals loosely associated actively participating on various l o g i s t i cal activitie s , inc l ud i ng scope of me e t i ng s, event s, and under no specific legal committees, which can include membership lists and ma i l i n g s, a d m i n i s t ra t ion. If the structure. screening, education, public Web site, minutes of committee o rg a n i z a t ion chooses to avoid relations, sponsorship, me e t i ng s, membership me e t i ng s, s p o nsorships but recognizes the 2 . No n p rofit corpora t i o n / 5 0 1 ( c ) : membership, finance, due c o o r d i na t i on of spons o r s, need for adm i n i s t rative support, Members operate under a mo re diligence, and the board or re c r u i t me n t, PR, etc. membership dues must be t ra d i t io n al corporate struc t u r e other governing body, if b udgeted to cover all ant ic i p a t e d with a board and of f ic e r s . S p o nsorship may also be appropriate. The members are c o s t s, plus a cushion. necessary in order to ge ne ra t e 3. Limited liability corporation responsible for organizational s u f f ic ie n t funds to pay salaries fo r Members typically ma k e their own (LLC): Gives similar activities and oversight. a dm i n i s t rative staff and cover i n v e s t m e nt de c i s ion, but some advantages and governance Many groups will hire an cost of ma t e r i a l s, ma i l i ng s, o rg a n i z a t io ns have annua l options as a traditional Executive Director and/or e duc a t io nal pro g ra ms, etc. i n v e s t m e nt minimu m s or fo r m corporation, with partnership administrative assistant to s e p a r ate investme n t vehic l e s, suc h form of member taxation. support the members in as LLCs, for pooled investme nt s . 4. Corporation: Traditional functional duties such as structure meeting coordination, member communication, etc. 5 . Limited (liability) partne r s h i p : Often related to VC fund s

38 ORGANIZATION ORGANIZATION GROUP DYNAMICS ADMINISTRATIVE AND MEMBERSHIP REQUIREMENTS TYPE STRUCTURE OPTIONS OTHER SUPPORT Manager-Led 1 . Limited liability corpora t ion Members are involved at various Staff includes a full- or part- In many manager-led groups, Groups levels depending on their time manager, often along with members have capital 2 . C o r p o ra t io n interests, market or industry administrative support. An MBA commitments, with the total 3 . No n p rofit/501(c) org a n i z a t io n expertise, and general desire. student may also be a member amount generally due at two or of the staff, often interning three closings, depending on 4 . Limited (liability) partne r s h i p Members often assist the through a local MBA program. the intended length of time for manager or can lead functional All of these types of investment. Investing can also efforts in strategic planning, The manager can often receive organizations can have a be by individual member choice. member relations, or investment part of his or her compensation formalized structure, with These organizations sometimes identification and selection. through a carried interest (the management responsible for have side funds, which make “carry”), thus giving the numerous activities, including bridge or complementary manager a greater stake in the screening and evaluating investments with members. investment process. prospective deals, group Investments can be through the investments, member Members are assessed an annua l angel organization or through communications, etc. fee to cover the ma na ger and separate, deal-specific legal a dm i n i s t rative costs. The T h e LLC struc t u r e is of t e n structures such as LLCs. ma na ger and adm i n i s t rative staff a s s o c i ated with an angel fund. can also be compensated thro u g h With angel fund s, members can a small perc e n t a ge of the u s ually invest add i t io nal amo u nt s committed capital (2% –3%), on an ind i v idual basis int o a l o ng with a possible carry. c o m p a n ies the org a n i z a t io n c hooses to invest in and may also O t her sources or group fina nc i ng invest outside the org a n i z a t i on as s uch as sponsorships can he l p an inde p e nde n t investor in no n - cover ma na ger costs. selected companie s.

39 G R O U P O P E R A T I O N S ( I M P L E M E N T I N G Y O U R A N G E L G R O U P )

You have now decided on the stru c t u re for your angel R E C R U I T M E N T , SCRE ENING, SELECTION, o rganization, including: AND ORIENTATION:

⁄ member versus manager led; Your selection process must reflect all desired member attributes, from possible skills and background to ⁄ legal stru c t u r e; investment beliefs. To align member selection with ⁄ investment process; group goals and investment structure, you should have: ⁄ membership; and ⁄ Written materials and/or a Web site clearly and accurately describing membership qualifications and ⁄ financial re s o u rces. requirements. (See Appendix 1 for sample In many respects, these decisions are the easy part, as the Membership Information Document.) actual operation of an angel group can pose the most ⁄ Written materials and/or a Web site describing your d i fficult issues. Proper and thoughtful implementation of o rganizational stru c t u re, possible investment your plan will determine the future of your gro u p , expectations, and group philosophy. A code of conduct member satisfaction, investment success, fulfillment of for members, which includes the respect of other your gro u p ’s objective, and group culture. members’ privacy and the confidential nature of i n f o rmation received at meetings, is always a good idea. M E M B E R S H I P ⁄ Member recruitment and selection committee Under the Building the Framework section of this members who understand your group and who can Guidebook, you went through various questions and effectively communicate, being group spokespersons exercises to determine who should be a member. and ambassadors. Properly identifying and communicating with those potential members is equally important. As many will ⁄ Committee members who are willing to thoughtfully testify, good communication is the key to any successful review applications, interview candidates, and host relationship, and an angel organization and its members prospective members at a group meeting. Committee are no exception. Early and complete communications members should ideally be well connected in the through written materials and/or Web site will minimize community. misaligned expectations.

40 ⁄ A membership application with qualifications, group BAC K G R O U N D / E D U C A TIONAL NE EDS: philosophy, code of conduct and ethics, and reasons Another important aspect of membership recruitment is for removal stated on the application. (See alignment of members’ expertise with group investment Appendix 2 for a Membership Agreement.) focus and needs. Additionally, even with identified ⁄ A stated mechanism and well-understood reasons for member selection criteria and needs, education is a vital termination of membership. component of any angel group.

⁄ An annual renewal and application review process ⁄ M e m b e r s’ backg r ound and experience in that includes member affirmation of accredited- i n v esting: Many angel organizations choose an investor status. (See Appendix 3 for Annual investment focus, such as software or life sciences. Membership Profile.) Such a focus may drive membership requirements or preferences but can also be a self-selecting attribute. A written process reflecting all these steps. ⁄ In other words, prospective members without any Potential members should be allowed the opportunity to experience in the area of a particular group’s focus experience a group meeting to gain comfort with the may not consider membership for lack of interest or g ro u p ’s meeting and investment process. Such a visit investment alignment. As will be discussed more allows the guest and the group to evaluate fit and mutual under deal screening and due diligence, logic dictates i n t e rests. Guests can be handled in a number of ways. that successful angel organizations will have members One effective mechanism is to offer complimentary who are experienced in various aspects of the group’s attendance at a meeting, including the meal, or charg e market focus (if your group chooses to have a focus). the guest a nominal amount. However, you should limit They will also have members knowledgeable regarding the number of “free lunches” and re q u i re a decision on the various attributes of a successful business, such as membership after a potential member attends a meeting. marketing, financing, information systems, research, People requesting additional meeting attendance before operations, manufacturing, human resources, and making their membership decision should be asked to senior management. By definition, angel organizations pay an amount equal to annual membership dues divided are made up of active investors, so, typically, members by the number of meetings per year. rely on one another’s expertise and objective analysis of potential investments to evaluate companies.

41 Therefore, in membership recruitment, your group TIME COMMITMENTS: should seek out potential members who complement Member willingness to volunteer time is an important the skills and experiences of existing members to give factor in determining whether your group should be the group a solid core of knowledge. manager or member led. Cost is also an important ⁄ Education pro g r a m s : Not all members join angel factor. The following list gives you an idea of the various groups with previous angel investing experience, and duties and responsibilities in an angel group. Of course, very few angels have adequate depth of knowledge in an informal affiliation would not require all of these all facets of investing. Part of the concept of an angel functions, but this structure also limits the size and organization is to cultivate new, active angel investors intent of the group. and to further educate members. Hands-on learning through just doing deals and informal mentoring by experienced members are valuable learning mechanisms. However, the fear is that critical and basic aspects of angel investing are missed in this semi-disjointed education.

One should strongly consider periodic intensive training for new members, including training on the basics of company assessment that covers many topics, from financial and market analysis to management. Such training can be done by the angel organization itself or through third-party education programs. Many angel groups also invite guest speakers to regular meetings to discuss relevant topics such as market trends and investment terms. As previously mentioned, such training and other speaking opportunities can provide value to sponsors. (See Appendix 4 for a list of typical topics covered in angel investor education.)

42 TA B L E 1 0 Organizational Activities and Duties

ACTIVITIES POSSIBLE RESPONSIBLE PARTY Governance: Members/board of directors (or equivalent), with support from ⁄ Strategic direction/philosophy/goals manager or executive director. ⁄ Development of operating documents ⁄ Development of operating plan Operations: Board committee, manager and/or executive director, with ⁄ Member communications support from administrative staff. ⁄ Web site development and maintenance Executive director or administrative staff with member ⁄ Meeting coordination oversight. A manager can handle all of these duties as well, ⁄ Training although fiduciary duty dictates that members must have ⁄ Speakers financial oversight or ultimate responsibility. ⁄ Finances, including dues and sponsors ⁄ Events Members can handle any or all of these duties on a volunteer ⁄ Group management basis. If you choose this structure, be cognizant of volunteer “burn-out,” consistency of structure and application from one group of volunteers to another, and loss of momentum.

Membership: The membership committee is an important attribute of any ⁄ Recruitment angel group. Executive and administrative staff can have ⁄ Screening varying degrees of responsibility, but members should have an ⁄ Relations active role in member relations. Deal sourcing (Potential sources of deals include members, Members are the best source of deal flow and, as such, need to professional service providers, entrepreneurial support groups, actively seek out potential companies. The group manager investment forums, and venture capitalists, along with your and/or administrative staff can handle the coordination of group Web site.) these activities. Deal scre e n i n g (By de f i n i t ion, angels are active investors, and one A selection committee made up of a subset of the members can of the important steps in the investme nt process is deal scre e n i ng . ) do initial screening to select presenting companies. E n t re p reneur communication ( Active and cons t r uc t i v e Managers often handle company communications, as can c o m mu n ic a t ion with applic a nt companie s, as well as with executive directors. Administrative staff can also coordinate the t hose chosen, improves the public ima ge of your group and correspondence, with member oversight of content. a t t racts good de a l s . ) Presentation coaching (Every selected company needs As with deal screening, member involvement in coaching is coaching before presenting at a group meeting. Your group may important. Some manager-led groups allow the manager to do have specific information needs, and companies should be most of the coaching, but for member-led organizations and at coached to include this information. Companies also need early stages of a group’s maturation, members should take an coaching on how to effectively communicate the essential active role in company coaching to better understand the aspects of their business in a short time period.) investment process. 43 ACTIVITIES POSSIBLE RESPONSIBLE PARTY Due diligence: Members should be involved in the due diligence process. ⁄ Coordination Administrative staff can carry out coordination, and a manager ⁄ Actual analysis can facilitate and support much of the actual analysis. However, to make intelligent, informed investment decisions, members must take an active role in due diligence. Investment: Seasoned management can negotiate the actual investment, ⁄ Negotiations with member involvement to ensure agreement with the terms ⁄ Coordination and to gain experience. Depending on group structure, the (In most org a n i z a t i o ns (70%), ind i v idual members ma k e the i r manager or executive director may be appropriate for own investme n t de c i s ion. Even with ind i v idual de c i s io n - ma k i ng , coordinating the actual investment. g roup due dilige n ce still has tre me ndous value and is one of the f u n da me n tal re a s o n s for establishing an angel gro u p . ) Investment follow-on (Once the investment is made, either Ma na gers are valuable for follow-on commu n ic a t io n s and upda t e s , through the group or individually, staying abreast of company as can be executive dire c t o r s . With member-led gro u p s, a lead progress and adding value as appropriate are essential.) investor often is chosen to ma i ntain the ongo i ng re l a t io n s h i p with the invested company and keep the other me m b e r s i n fo r me d. If the group investme nt is sig n i f ic a nt, a board positio n may be ne go t ia t e d , and the lead investor or a de s ig nated gro u p me m b e r, if invested as a group, may take the board seat. P romotion/public re l a t i o n s ( T h e first re a c t ion to this catego r y All members of an angel group should be considered group is why does an angel group have to worry about pro m o t io n ? ambassadors. A board committee, manager, or the executive Ho w e v e r, a group will have little or ina p p ro p r iate deal flow director can coordinate activities. The Web site can serve as unless the re is public fa m i l iarity with the group’s ex i s t e n ce and the primary window into your group, with the content well i n v e s t me nt fo c u s. Web sites, community involveme n t in re g io na l thought out and kept current. i n v e s t me nt fo r u m s, and pro m o t ion of a positive public ima ge are c r i t ically important to the success of an angel gro u p . )

44 MEETING STRUCTURE ⁄ What preparation is needed for meetings? How will you handle meeting announcements and RSVPs? Surprisingly, meeting time, format, and content can What kind of information should be provided? Who often be the most difficult points of agreement for will coordinate logistics? members. For anyone who has scheduled meetings or put on events, everyone has different schedules, ⁄ How far ahead of meetings should the screening different interests, and individual circadian rhythms. committee meet to select the presenting companies? Here are some parameters to consider: Do you plan to coach the presenting companies, and, if so, how much time is needed before the meeting?

TIMING AND LOCAT I O N : ⁄ What are the manager/executive ⁄ How often? Monthly or semi-monthly? Summer director/administrative staff responsibilities? and/or holiday hiatus? ⁄ What is the timing of board or committee meetings in ⁄ Time of day? Meal included? relation to regular member meetings? ⁄ Meeting location for convenience of members? Same or ⁄ Who is responsible for the Web site? What rotational locations? Parking issues? Need for privacy? information should be included? Should there be a members-only section? Do you wish to post all company applications for member access? F O R M A T:

⁄ Length of meeting? E D U C A T I O N :

⁄ Networking time desired? With or without presenting ⁄ Do you want regular educational sessions as part of companies present? member meetings?

⁄ How will group business be handled? ⁄ If so, would you like guest speakers? Can ⁄ Where in the meeting schedule are company management handle speaker coordination, or should presentations? Will you require a PowerPoint or other there be a member committee on education? presentation materials from companies? ⁄ Do your members need intensive, initial training on ⁄ Do you desire a “members-only” session after angel investing? Should other members, local company presentations? Does your location professional service providers, or third-party programs accommodate such an arrangement? conduct the training?

45 And the list goes on. As we all know, better up-fro n t planning makes for well-executed meetings and happy members. Planning also impresses presenting companies, which drives deal flow.

GROUP BU DGET

Earlier in the Guidebook, we talked about various sources of financial support for your angel group; now, to give you a start on operational costs, the following table lists possible expense items and a rough cost range. These costs have a fair deviation and are influenced by multiple factors, including group structure and regional fee rates. Therefore, these costs should be considered a gross guide only.

TA B L E 1 1 EXPENSES* RANGE Group Expenses Management: ⁄ Manager ⁄ $70,000 to $150,000 ⁄ Executive Director ⁄ $50,000 to $80,000 ⁄ Administrative support (and benefits) ⁄ $25,00 to $45,000 You can also use percentage of carry as part of compensation if Some groups have MBA students working for a nominal amount the organization is structured to accommodate such form of and/or earned credits through an approved program. compensation. Some groups also share administrative support with other organizations, decreasing this cost and better Along with geographic factors, responsibilities and duties aligning need with expense. influence the cost of management. Web site development and maintenance $3,000 to $20,000 for de v e l o p me nt; $2,000 to $6,000 for annua l ma i nt e na nc e. This is an area in which you may be able to ide ntify an in-kind sponsor if compatible with group int e r e s t s. Meetings: $25 to $45 per attendee, depending on meeting location, room ⁄ Member (including a meal–lunch for this analysis) charges, beverage coverage, guests, etc. Sponsors may wish to ⁄ Board (including a meal) offer their facilities for board and committee meetings, which ⁄ Committees (not including a meal) will lower your overall budget.

46 EXPENSES* RANGE Member relations and communications/correspondence: $7,500 to $75,000. Many groups are trending toward e-mail as ⁄ Meeting announcements the only mechanism for member communication, either in ⁄ Program announcements coordination with the group Web site or not. Surveys can also ⁄ Letterhead be conducted online, and many people actually prefer this ⁄ Annual surveys format. Other groups prefer the look and image of mailed ⁄ Membership info r ma t ion packet and gifts (mu g s , portfo l i o s, etc. ) invitations and announcements. Events and large programs are ⁄ Newsletters better suited to traditional mailings. Events and programs often ⁄ Important events or occurrences have specific sponsorships, which can cover these costs. Public relations: $5,000 to $50,000. As with so many other cost estimates, the ⁄ Logo and image development range is broad, depending on whether you want just a logo or ⁄ Promotions plan desire a substantive promotions plan. In-kind sponsorship may be possible for this particular category, including member gifts noted above. Office expenses: $15,000 to $200,000. Your group may be able to share space If you have de d icated staff and need to pro v ide of f ice space. with another organization or sublet space from a sponsor to Also inc l uded are opera t io nal costs related to mo s t minimize costs. Office expenses can be lower if entirely member o rg a n i z a t io ns, such as postage, banking servic e s, and ins u ra n c e. led, with no management or other administrative staff, which ⁄ Office rent would limit costs to only a few items. ⁄ Office furniture ⁄ Office equipment ⁄ Utilities ⁄ Postage, courier ⁄ Professional fees ⁄ Insurance (D & O and general comprehensive) ⁄ Banking services Programs/events: For most gro u p s , special events and pro g ra ms, even for me m b e r ⁄ Member training t ra i n i ng , s hould be covered by the re v e nue sources for those event s. ⁄ Investment forums ⁄ Public educational programs

The “Angel Equity Survey” created and managed by EMME Consulting showed in its Q1 2003 Pre l i m i n a ry Results that annual administrative costs varied significantly, with a range of $300 to $300,000, with an average annual administrative cost per investor of $1,054 (median $1,000). The administrative costs per investment opportunity averaged $6,700 (median $1,230) per business proposal “viewed” and $16,441 (median $10,000) per proposal “seriously considere d . ”

* All expenses are based on FTE annual salary for management and annual cost basis. Venture capital funds provide a good comparison for manager-led organizations. (Appendix 5 is a revenue and expenses worksheet for your use in developing a budget.) 47 S P O N S O R S H I P S ⁄ Clearly articulate the rules of attendance for sponsors. Let a sponsor know that their pre s e n c e As discussed under the Building the Framework s e c t i o n , is to be low key. Allow sponsors to place marketing sponsorships can be an effective and viable mechanism materials at a designated location in the room, but not for funding (at least partially) your angel group expenses. set up booths. Spiffs or give-aways are often fun or Many groups shy away from sponsorships because of the useful, so allow sponsors to place items by their fear that meetings will become a vendor event rather materials or on dining tables, but with quantity and than staying true to angel investing. There are steps that f requency contro l s . can be taken to prevent or minimize sponsors monopolizing the meetings. At the same time, one must ⁄ E n s u r e that sponsors understand and value your gro u p remember that sponsorship is not provided out of p h i l o s o p h y, goals, and objectives. The better every o n e c h a r i t y, but rather sponsors re p resent legitimate and understands each other, the greater opportunity there i m p o rta nt business services and need recognized benefits will be for a successful relationship. Be honest and up for their dollars. f ront about limitations and re q u i re m e n t s .

CONTROL OF SPONS ORSHI P AC T I V I T I E S : SPONSORSHIP BE NEFITS: ⁄ Limit the number of sponsors. If you have a ⁄ I n t e r action with members at meetings. tiered sponsorship structure, you may want to offer Sponsors are unlikely to sign up unless they exclusivity for particular professional categories (e.g., understand the opportunity to interact with group accounting, law, investment banking) for the highest members. But, as discussed above, the number of sponsorship level. The overall number of sponsors representatives should be limited. should remain at a level such that representatives will ⁄ E x clusivity for top-tier sponsors h i p . If you still be a minority of meeting attendees. create a tiered sponsorship structure, you can often ⁄ Limit the number of sponsor re p r e s e n t a t i v e s . give the top-tier sponsors exclusivity in their Even for large, top-tier sponsors, meeting attendance professional category (e.g., one law firm, one must be limited to two or three representatives. A rule accounting firm). This gives a sponsor the comfort of of thumb is a ratio of six members to one sponsor having no competition in their professional field. representative at a meeting (a total for all sponsors).

48 ⁄ M a r k eting materials and promotional materials. ⁄ C o m p a n y coaching. Sponsor representatives may As discussed above, allow sponsors to place marketing be very effective coaches for company presentations. materials at a designated location, but shy away from This also allows sponsors the opportunity to interact booths, which can dominate a meeting. Items such as with promising new businesses and possible new pens and stress balls can be placed by marketing clients. Coaching often needs a set location, which materials or on dining tables. Passive use of materials particular sponsors can provide. satisfies sponsorship needs for take-away reminders ⁄ M a i l i n g s . Be very careful about sharing member lists. but allows members the choice of taking or not taking Nothing drives a member away faster than receiving the materials. copious amounts of unsolicited mail. Be sure to ⁄ Tra i n i n g / s p e a k e r s / e vent coord i n a t i o n . control all member correspondence. Give sponsors the Sponsors can play a valuable role in coordination of opportunity to post useful information on the Web group training, guest speakers, and events. Not site, such as due diligence tips and invitations to surprisingly, sponsors are attracted to groups and sponsor events of possible interest to members. events that complement their area of professional ⁄ Ta b l e s p o n s o rs h i p . P e r i o d i c a l l y, you may wish to off e r expertise. Coordinating and conducting member sponsors the chance to host a table at an event, at which education and training can be a very effective way for time they can invite prospective, qualified members who sponsors to showcase their skills. Sponsors often have may have some relationship to the sponsor. This gives the good connections to relevant speakers and would sponsor an opportunity to impress clients and to incre a s e enjoy introducing speakers at member meetings. membership for your gro u p . Events such as investment forums also fit well with sponsor interests.

⁄ Web site and pro g r am re c o g n i t i o n . An easy benefit to offer is prominent display of sponsor logos on the group Web site, in meeting programs, and even on group letterhead. This also allows for recognition of sponsorship level, if you decide to offer tiered sponsorships.

49 INVESTMENT EVA L U ATION AND PROCESS ⁄ Another source of deal flow is ve n t u r e capital f u n d s . Venture funds often receive business plans The investment process can take many forms. These range from entrepreneurs too early-stage for VC investment f rom members making their own investment decisions to needs and interests. Inviting regional venture capital investment of group funds based on committee or funds to be associate members or establishing an manager recommendations. The actual investment ongoing relationship with these venture funds can s t ru c t u re can vary from individual investments to cre a t i o n provide an early look at companies for VCs and of a limited liability company for each investment to encourage them to send interesting business plans for investments from an established fund. For purposes of this your group’s investment consideration. Additionally, discussion, let’s walk through the entire investment VCs may offer the angel group limited opportunities p rocess, discussing alternatives for each step. to participate in first-round venture financings because of the positive aspects of this relationship. DEAL SOURCING ⁄ I n v estment fo r u m s and similar events can be a good The success of any angel organization is ultimately s o u rce of presenting companies, as these businesses based on the quality of investment opportunities have generally already gone through some form of available for its members. Generally, members are the s c r eening to qualify for presentation at the foru m . best source of business plans. If members are active investors in the community, they will usually have a ⁄ Some groups have also found good potential deals known reputation and have their own deal sources. through local unive r s i t i e s that have a strong These sources include many of the following: technology-transfer program and enterprise centers, which support development of entrepreneurial ⁄ Service prov i d e r s, such as lawyers, accountants, companies and community entrepreneurship. and investment bankers, are good sources of deal f l o w. Many conduct their own analysis of early-stage ⁄ Direct application through a g r oup Web site can companies before agreeing to accept them as clients. generate possible investment companies, although If sponsorship is one of your group funding sourc e s , most angel investors generally prefer a referral from a p roviding an opportunity for sponsors to submit clients member or trusted service professional. for possible presentation can be a defined benefit.

50 Even with companies sourced through members, tiered review approach, with initial selection of several p rofessional service organizations, VCs, and other companies for presentation to the screening committee. methods, the best angel groups use one uniform From these presentations, a smaller number (say two to mechanism for company applications, typically the four companies) can be selected to complete the angel group Web site. This provides an opportunity to coaching process and eventually to make presentations i n f o r m applicants of your rules of presentation as well at a group meeting. as the screening and selection process, and to handle Some groups have MBA interns serve on the screening any charges associated with company applications. As committee alongside members, often completing initial such, groups should route all applications, re g a rd l e s s screening of all applications against a list of group of source, through one channel, such as a Web site or criteria. Duties may also include interviewing the e-mail address. (Appendix 6 shows a list of company entrepreneur to obtain needed additional information as i n f o r mation re q u e s t s . ) part of the evaluation process. The MBA students then create a report for the screening committee. DEAL SCRE ENING For purposes of maintaining uniformity and controlling As with nearly any aspect of an angel organization, the the number of hours each screening committee member screening process can vary from informal, with selection must commit, it is recommended that organizations conducted by volunteer members, to a formal process in accept only executive summaries from applicant which the manager coordinates and conducts much of companies. In addition, as mentioned above, it is best the screening. The screening process provides a that all applications come through one avenue, whether mechanism for selecting companies that the entire angel that is the group Web site, the screening committee group will review, typically through presentations at chair’s e-mail, or the group manager’s address. member meetings. Regardless of the level of formality, Screening should be done using a well-developed and some type of screening process should be established to uniform evaluation form or matrix. Such forms help to avoid taking up the members’ limited time at periodic ensure that evaluations are thorough, fair, and objective. meetings with business plans not worthy of investment (See Appendix 7 for a sample Screening Worksheet.) review and consideration. Individuals volunteering to review applications should be experienced in evaluation of early-stage companies. Depending on the number of applications, an organization may wish to consider a

51 For groups with screening committees comprised of include in their presentation and meeting handouts. members, have a small group of experienced angel Sponsors (such as law or accounting firms) are often investors lead the screening process, with two or three keenly interested in providing these coaching services at apprentice members learning the ropes but not voting no cost and, in fact, as a benefit of sponsorship. These on company selection. Learning angel investing occurs s e rvice providers see the opportunity to coach pre s e n t e r s in many forms, and this type of mentoring and hands- as a chance to promote their services and possibly obtain on education can be beneficial. a new client that is already considered a cut above.

Some groups require presenting companies to have a Most companies see coaching as a benefit, particularly if member sponsor them, with at least one member a group charges companies for applying and/or agreeing to invest or having already invested in the p resenting. As with other steps in the investment company. Such requirement for a “guardian angel” has p rocess, the manager of a manager-led organization may decreased in popularity with recent reductions in take on the responsibility of coaching companies along investment activity and the fact that this process does with other aspects of deal screening and investment. The not necessarily guarantee better deal flow. Some groups allocation of these various responsibilities will depend on do have a member assigned to a presenting company member pre f e rences, interest in participating in various for purposes of shepherding or mentoring them through steps of the process, legal stru c t u re, group collective the coaching and presenting process. For manager-led experiences, and manager experience, as well as the level groups, the manager often takes on this role. of organizational funding (i.e., more work by the manager and staff equals greater overhead costs). C O AC H I N G C O M PANY PRESENTAT I O N S As previously mentioned, quality deal flow is a critical factor for the success of any angel org a n i z a t i o n . Many groups have company presentations at re g u l a r Experienced angels want to see the best opportunities in g roup meetings. Ty p i c a l l y, two to four companies town and entre p reneurial teams with good p resent for a limited time frame (ten to fifteen communication skills. Coaching the selected businesses minutes), followed by a short question-and-answer can make a significant diff e rence in ensuring that session (five to ten minutes). After the pre s e n t a t i o n s , companies present the right information, in an eff e c t i v e many groups ask the companies to step out of the f o rma t, using their best re p resentatives. Some gro u p s room for group discussion of investment interest. This give presenting companies exact instructions on what to g roup-only discussion time serves a greater purpose

52 than just a determination of “go” or “no-go” for rather than the steps and topics for due diligence. p resenting companies. Members have the opport u n i t y (Sample due diligence questions and a checklist are to share additional information they may possess about p rov ided at Appendices 8 and 9, re s p e c t i v e l y.) In a the market, product innovation, and management, and m a n a g e r-led organization, the manager will typically to develop an effective message to communicate to lead the investment-evaluation process. The manager the entre p re n e u r, particularly if that business is not will also often negotiate the stru c t u re of an selected for continued funding consideration. These investment or participate in the negotiation pro c e s s discussions also provide an excellent learn i n g with the lead investor. In member-led groups, whether experience for new members. an informal group with individual investment decisions or one in which members invest collectively, the due Your actual group stru c t u r e will dictate a variety of diligence process must ensure coverage of re l e v a n t a p p roaches to follow-up activities. For instance, if you are topics and should be conducted by those with member led and members make their own investment experience and expertise in particular areas. Some decisions, you may have a process in which those g rou ps retain MBA students to support due diligence members expressing an interest in continuing discussions t h rough an internship program with the local business with a presenting company form a due diligence school. Other groups retain outside experts to committee to thoroughly evaluate the company. That evaluate a company or give a briefing on cutting-edge g roup could then divide up the duties depending on technology related to the potential investment. e x p e rtise, with investments still being made on an individual basis. At the other end of the spectrum, if the One angel group with a sidecar fund has the fund g roup is an angel fund, the group may vote on whether complete all due diligence on companies presented to to proceed with due diligence and members may be the related angel group. Based on this due diligence, identified to support the diligence process based on their the fund members vote on whether or not to fund at b a c k g round and expertise, often led by a manager. the meeting. If the side fund decides to fund a c o m p a n y, it then shares the results of due diligence DUE DILIGENCE with interested members of the angel group to ro u n d out the investment offering. Due diligence can be the most complicated and time- consuming part of angel investing. Many publications have been devoted to the due diligence process. This discussion is limited to suggestions for stru c t u re ,

53 INVESTMENT VEHICLES funding needs and the possible sources for this additional company capital. Do not make the terms so Needless to say, there are a variety of investment complicated or onerous to effectively prevent attracting mechanisms and nearly countless number of investment follow-on financing, which is undesirable for the terms. (See Appendix 10 for a glossary of private company and angel investor. financing terms.) Angels invest locally for many reasons, including an interest in staying connected to the The purpose of this Guidebook is to relate these portfolio company, familiarity with the local market, and activities to various angel group structures rather than to desire to give back to the community. A few exceptions discuss terms and negotiation techniques. Your angel are organizations with an investment focus that requires investment training should include a fairly lengthy a broad geographic review of potential deals, such as session on terms, which can seem complicated and sustainable technology, energy efficiency, hopelessly confusing to the new investor. Local environmentally friendly products, or companies with a professional service providers, such as lawyers and social-venture aspect. Therefore, throughout the accountants, often have extensive hands-on experience process, from deal sourcing to signing the investment with investment terms and negotiation techniques. check, local investments prevail. F rom an operational perspective, in manager-led groups, the manager often plays an integral and key role in determ i n i n g INVESTMENT TERMS AND NEGOT I A T I O N S and negotiating investment terms. A manager’s (and, for An essential part of the investment process is the form that matter, a member’s) ability to negotiate investment of investment. This Guidebook will not deal with the t e rms will depend on a few key factors: differences between debt and equity, common versus ⁄ Is your group the lead investor? If not, you probably preferred stock, or the multitude of possible investment have little influence over the terms and must rely on terms. See Appendices 11 and 12 for sample term the sophistication of the lead investor to negotiate sheets with investor-favorable and company-favorable investor-favorable terms. If a VC fund is leading the terms and annotations, respectively. These term sheets round, you will most likely receive favorable terms. are very comprehensive and more reflective of a venture capital fund financing, but do give an excellent ⁄ Does your manager (or do your members) have the evaluation and consideration of numerous terms and requisite experience? With the first few investments, options. Angel investors, often being the first outside and even thereafter as a safety factor, professional money in a company, need to be cognizant of follow-on advice should be sought and used.

54 ⁄ Has the company already established terms, and does F O L L O W-ON RELATIONSHIPS AND AC T I V I T I E S it have multiple potential sources of funding? One of the reasons angel investors invest almost Entrepreneurs usually know if they are a “hot” deal. If exclusively on a regional basis is the desire to stay close this is the case and you want to play, both your ability to their investments. to get in on the deal and your negotiation leverage may be limited. So what type of relationship should an angel investor expect from an investment? The answer will depend to a LIABILITY AND RISK EXPOSURE g reat extent on investment size, specifically the p e rcentage of the round or the percentage of the With any structure in which members make company acquired by the angel investor or angel gro u p . independent investment decisions, there should be a Taking the lead position in a funding round pro v i d e s strong disclaimer of organizational liability. The leverage to request a board seat or board - o b s e rv a t i o n disclaimer should indicate specifically that each member rights. Whether an angel investor, or re p resentative of an makes his or her own investment decision and that the angel fund or pooled investment, takes a board seat at all organization is not recommending any particular is another question entire l y. The answer depends on fit company for investment. (See Appendix 2, Membership with existing board members, skills needed on the board , Agreement for sample disclaimer.) Members with a investor recognition of the increased time commitment, relationship to any company presenting (e.g., as a board and possible increased liability exposure as a dire c t o r.1 1 member, advisor, officer, or current investor) should Outside of the more active role of board dire c t o r, all disclose to the group their relationship with the angel investors should insist on information rights, which presenting company to ensure fair and equitable review include, at the very least, annual financial statements and of a potential investment. In theory, with greater annual re p o rt. Some investors ask for management organizational structure, you should provide insulation visitation rights, and others request additional from liability for board members and others actively i n f o rmation, such as all business plans, quart e r l y involved in organizational management. However, there financials, and annual operating plans. The amount and are no risk-free circumstances, and you should consider quality of information you receive will depend on your obtaining insurance for directors and officers, as d e s i red level of involvement and the company’s appropriate, depending on your legal structure. willingness to share information with a minority investor.

11 Recent regulations, particularly under the Sarbanes-Oxley Act, raise further concerns about director liability. One should consult counsel about possible 55 liabilities before accepting a board position. Some angel investors also become advisors or mentors The gro u p ’s organizational stru c t u re will determine the to the company, serving on an advisory board or need to actively re c ruit members. Small informal gro u p s committee. Caution dictates that angel investors should that are satisfied with their membership stru c t u re and not demand a paid advisory role as a quid pro quo for numbers will not be interested in public relations fro m their investment. Such arrangements border on a fee- the context of additional members. But even for such for-investment arrangement, which can create multiple g roups, some level of public awareness is important, if securities law issues for you and the company. Advisory just to ensure good deal flow. For groups interested in boards (as with board of directors) in early-stage re c ruiting, membership benefits and obligations must be companies may receive options for their services, with a clearly articulated in written materials and/or on the vesting schedule correlating to the time of service. g ro u p ’s Web site. This allows the membership committee to present a well-organized group with understood Equally important in the follow-on relationship is the goals, objectives, and philosophy. tracking of investments. Individuals and groups should have a list of information categories that are periodically Public familiarity with an angel group helps with deal analyzed. Groups should have a reporting system for flow, often increasing quality deals and applications that sharing this information with the entire group. relate to the group’s investment goals. Angel groups Organizations may even wish to periodically survey may wish to host an investment forum or participate on companies, members, and selected members of the various committees for investment or entrepreneurial public about group perceptions, company experiences, programs. All these activities relate to image and public and member satisfaction. (See Appendix 13 for sample face. The more that is known of your group’s active Public Survey.) investment history, intelligent and thoughtful review of applications, and active involvement with portfolio P R O M O TIONS/PUBLIC RELAT I O N S companies, the more the group’s reputation will be enhanced, and the more new members and good This section is not intended to suggest that angel gro u p s investments will be drawn to the group. should take out glossy ads in local business publications, but rather as a recognition that, for many gro u p s , community awareness or public familiarity is essential for quality deal flow and member re c ruitment. Most gro u p s want to be known for their professional stru c t u re and p rocesses, supportive environment, and positive culture .

56 SUMMARY OF GROUP OPERAT I O N S The most important reason for (and initially the single reason) forming your angel group is investing. The This discussion of angel group operations may have left Building the Framework section of the Guidebook you wondering how to successfully pull everything took you through the formation process, keeping in together. The appendices should help you with many of mind, at all steps, this investment purpose and allowing the mechanical processes. Also, knowing that many that investment vehicle to steer you in the right dire c t i o n other angel groups have started and continue to for stru c t u re, membership, etc. Similarly, the G ro u p operate successfully should give you comfort that you O p e r a t i o n s p a rt has covered the investment pro c e s s are not alone. In a recent publication, Angel Healthcare once the group is operating. In summarizing the Investors, LLC summarized the attributes of their group investment process from the operation’s perspective, that relate to their continued success and sustainability. t h e re are a few simple rules which will bode well for This table references many of the discussions and topics your group re g a rdless of stru c t u re or process. There f o re , in this section of this Guidebook: what are some of the basic points of angel investing?

⁄ Keep the terms simple if follow-on funding, TA B L E 1 2 1 2 p a r ticularly from VCs, will be necessary. Nothing can AHI Tactics for Promoting Sustainability p rev ent follow-on funding faster than an overly PROCESSES TRADITIONS COMMUNICATIONS complicated and burdensome first round, which a VC New-member packet Annual meeting Investment memos must try to unwind, often demanding a discounted value and other “cram-down” re q u i rements to off s e t Deal-flow process Summer meeting in Cape Cod Angel Healthcare Web site o n e rous or overreaching first-round term s . Subcommittee process Member Spotlight Meeting minutes Investment process Member breakfasts Portfolio updates ⁄ R e s e r v e an investment amount if you expect to s u p p o rt the next round of funding. With the evaporation Secure file sharing Annual staff outing Guest speakers of VC capital in early-stage financing, more and more Monthly planning meeting Henderson house meetings AHI Box Score angel groups must fund the second round of financing. Monthly member meetings Member booklet Secure member Web site One of the biggest concerns for angel investors is lack of follow-on funding. In addition, entre p reneurs often need m o r e funds than they originally expected in order to meet the goals connected to the funding round in which the group participated. If this is an issue, one must plan for this possible need or work to help the company find the next round of funding; otherwise, you have just t h rown your investment away. 12 Excerpt from “State of the Art: An Executive Briefing on Cutting-Edge Practices in American Angel Investing,” p. 155, The Darden School Batten 57 Institute University of Virginia 2003 ⁄ Use professional service prov i d e r s who are ⁄ Be re a l i s t i c . Investing in any venture has risk, and familiar with all aspects of early-stage investing and early-stage investing re p resents particularly high risk, your specific investment structure. Regulations contain with little or no company track re c o rd, no market, many unexpected and undesirable tax consequences, and unproven technology. An investor must have the and certain combinations of terms or even phrases capacity and willingness to lose his or her entire can have negative results. i n v e s t m e n t .

⁄ Double-check due diligence and ask yourself: ⁄ Do not put all your investment eggs in one A re all areas covered? Was information objectively b a s k e t . A balanced portfolio will help ease the reviewed? Is the company stru c t u red appropriately pain of a bad investment decision. Do not expect for investment? Do you understand the reasons for all, or even most of your investments to be investment? Do you understand the risks and potential h o m e r uns. Statistics are not in your favor. Most for re t u r n on investment? angel investors continue this form of high-risk investing because their overall, long-term re t u r n is positive and because of personal satisfaction and I N V E S T M E N T S TAT I S T I C S : Looking again at the results of the 2003 CVR i n t e rest in working with entre p re n e u r s . angel group survey, we find: As with the Building the Framework part of this ⁄ 70% of responding angel groups leave investment decisions up to the Guidebook, stay nimble and willing to accommodate individual members. your group’s changing needs. This means good up-front ⁄ 23% of the angel groups invest by majority group decision. development with contingency planning. But most i m p o rt a n t l y, have fun. Enjoy the entre p reneurs you choose ⁄ Of those that invest by majority decision, 90% are structured as LLCs, which to work with or invest in, enjoy the investment process, is the preferred fund structure. This is further reflected in the unanimous and enjoy spending time with your group members. response to a question on pooled investment funds, for which all affirmative respondents were LLCs.

⁄ 7% of angel groups invest through investment committee decision. Good luck.

⁄ No responding angel group required unanimous decision for investment.

58 A P P E N D I X 1 A N G E L S A N O N Y M O U S 1 M E M B E R S H I P I N F O R M A T I O N

W H A T IS ANGELS ANON YMOUS? 2

Angels Anonymous (AA) facilitates the introduction of entrepreneurs to potential investors through presentations and other mechanisms. AA consists of individual angel investors interested in financing privately held companies or ventures typically in an early stage of development.

AA is focused on potential investments in the biopharmaceutical area. Potential members must have prior experience in the biopharmaceutical market or a strong desire, willingness, and capability to learn substantive components of the biopharmaceutical industry.

H O W DO I BECOME A MEMBER?

REQUIREMENTS OF MEMBERSHIP:

⁄ Members must qualify as:

An “accredited investor” as defined under Rule 501 of the SEC regulations, which defines an individual accredited investor as: “Any natural person whose individual net worth or joint net worth with that person’s spouse at the time of his purchase exceeds $1,000,000”; OR “Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.”

⁄ Members must be ______.3

⁄ Members must be sponsored by a current member. ⁄ Members must agree to abide by the terms and conditions of the AA Membership Agreement. ⁄ Members must pay annual membership fee.

⁄ Members must make minimum angel investments of $______per year.4

1 “Angels Anonymous” is a fictitious angel group and is merely a name used for example purposes. 2 This information document uses an example of an angel organization with a specific investment focus, namely, biopharmaceutical, to call attention to the need to identify such membership re q u i rements in the information documents and all other communications. If your group has other restrictions such as gender, those should be specifically noted in all information communications. 3 Here is where specific requirements of membership may be added such as prior angel investing experience, industry experience, gender, geographic location, etc. 1.1 4 A minimum investment requirement is becoming more prevalent; though required investing does not necessarily have to be through the angel group. PROCESS FOR MEMBERSHIP QUA L I F I C A T I O N :

⁄ Qualifying individuals are invited to consider becoming members of Angels Anonymous. Membership is at the discretion of AA’s Membership Committee and is subject to annual renewal, non-renewal, revocation or termination by AA’s Membership Committee.

⁄ Interested parties must complete the Membership Agreement and Membership Survey, and submit the same as directed on the Membership Agreement.

⁄ The Membership Committee will review all applications for membership and endeavor to provide applicants with a written response within thirty (30) days of completed application submission. (Your payment, whether by check or credit card, will be held for processing until after your membership has been approved.)

⁄ AA membership may be terminated or membership revoked at the discretion and determination of AA Membership Committee, should it be determined that an AA member has breached any term of AA membership. A member will be notified in writing by the Membership Committee of the intent to terminate or revoke membership, and the on-notice member shall have thirty (30) days in which to submit a written response to the Membership Committee, should the member deem his/her actions or inactions do not warrant or qualify for termination or revocation of membership. The Membership Committee shall consider, in good faith, such on- notice member written response within sixty (60) days. The decision of the Membership Committee is final.

1.2 W H A T ARE THE BENEFITS OF MEMBERSHIP?

⁄ Events – Monthly investor luncheon meetings with presentations from two to four pre - s c reened companies for members’ investment consideration. Afterw a rd, there will be time for discussion of members’ observations and a n a l y s i s .

⁄ Access to “Members Only” section of the Web site, which includes: ⁄ Access to all deal flow through AA’s online database. ⁄ Copies of all presentations and materials provided at meetings. ⁄ Member Discussion Areas online forums to confidentially discuss or comment on business plans, companies and general angel investing topics with other members. ⁄ Best-practice sharing of investment tips and documents.

⁄ Educational programs in term sheets, balanced investment portfolios, case studies, due diligence and other topics in angel investing.

⁄ O p p o r tunity to interact with other angel investors and meet individuals experienced in working with young c o m p a n i e s .

F R E Q U E N T L Y AS KED QUESTIONS ⁄ What is an angel inve s t o r ?

An angel investor is an individual who makes direct investments of personal funds into a venture, typically early- stage businesses. Because the capital is being invested at a risky time in a business venture, the angel must be capable of taking a loss of the entire investment, and, as such, most angel investors are high-net-worth individuals. These individuals are nearly always “accredited investors” as defined under the Securities Act of 1933.5

5 “Accredited Investor” as defined in the Securities Act of 1933 for individuals means: “a natural person who has individual net worth or joint net worth with the person’s spouse that exceeds $1 million at the time of the purchase;” OR “a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income 1.3 level in the current year.” ⁄ What is an angel gro u p ?

An angel group is a formal or informal assemblage of active angel investors who cooperate in some part of the investment process. Key characteristics of an angel group are: control by member angels (who manage the entity or have control over the entity’s managers), and collaboration by member angels in the investment process.

⁄ Is membership in AA re s t r i c t e d ?

Yes. Please see the description of membership requirements above, and review the entire content of the Membership Agreement.

⁄ H o w do I learn more about angel inve s t i n g ?

AA conducts periodic training programs for new members as an intensive introduction to angel investing. Periodically, AA has speakers on relevant topics as part of the monthly meetings. Members also learn from other experienced angel investor group members.

FURTHER QUESTIONS ⁄ Other questions that should be answe r ed in your members h i p - i n f ormation document include: ⁄ Must I make a minimum number (or amount) of investments each year in order to remain a member? ⁄ Is there a minimum or maximum amount of money I may invest? ⁄ How will investment decisions be made? ⁄ How will presenting companies be selected? ⁄ May I invest in addition to the amount invested by the group? ⁄ How is due diligence conducted? ⁄ How is AA run? (Administration, board, etc.) ⁄ How is AA funded?

1.4 A P P E N D I X 2 1 A N G E L S A N O N Y M O U S 2 M E M B E R S H I P A G R E E M E N T

Angels Anonymous (AA) facilitates the introduction of entrepreneurs to potential investors through presentations and other mechanisms. AA consists of individual angel investors interested in financing privately held companies or ventures typically in an early stage of development. Membership in AA is a privilege, which is subject to renewal, revocation, or termination for a member’s failure to conduct him or herself in a manner consistent with AA’s (one or m o re of the following: By Laws; Code of Conduct; Code of Ethics; Confidentiality Requirements; this Membership Agreement; Operating Agreement; Membership Requirements).

PROCESS FOR MEMBERSHIP QUA L I F I C A T I O N :

⁄ Qualifying individuals are invited to consider becoming members of Angels Anonymous. Membership is at the discretion of AA’s Membership Committee and is subject to annual renewal, non-renewal, revocation, or termination by AA’s Membership Committee.

⁄ New members must be sponsored by a current AA member. ⁄ All new members (and renewing members) must complete this Membership Agreement and the Membership Surv e y. ⁄ Applications and Surveys may then be forwarded by email or mail to AA at the addresses noted below.

⁄ The Membership Committee will review all applications for membership and endeavor to provide applicants with a written response within thirty (30) days of completed application submission. (Your payment, whether by check or credit card, will be held for processing until after your membership has been approved.)

⁄ AA membership may be terminated or membership revoked at the discretion and determination of AA Membership Committee, should it be determined that an AA member has breached any term of AA membership. A member will be notified in writing by the Membership Committee of the intent to terminate or revoke membership, and the on-notice member shall have thirty (30) days in which to submit a written response to the Membership Committee, should the member deem his/her actions or inactions do not warrant or qualify for termination or revocation of membership. The Membership Committee shall consider, in good faith, such on- notice member written response within sixty (60) days. The decision of the Membership Committee is final.

1 For angel organizations in which members make their own investment decisions. Attributes may also be used for a Code of Membership Conduct/Ethics. 2 “Angels Anonymous” is a fictitious angel group and is merely a name used 2.1 for example purposes. Name: ______

Address: ______

Phone: ______Fax: ______

Email: ______

New Member: ______Renewing Member: ______

If New member, Sponsoring Current AA Member: ______

TO QUALIFY FOR MEMBE RSHIP, I AGREE THAT:

⁄ I am an accredited investor as defined under Rule 501 of the SEC regulations, which defines the same as: “Any natural person whose individual net worth or joint net worth with that person’s spouse at the time of his purchase exceeds $1,000,000”; OR “Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.” OR

⁄ I have such knowledge and experience in financial and business matters to be capable of evaluating the relative merits and risks of any investment.*

⁄ I agree to abide by the terms and rules of AA’s (one or more of the following: By Laws; Code of Conduct; Code of Ethics; Confidentiality Requirements; this Membership Agreement; Operating Agreement; Membership Requirements).

* In order to maintain a high investment profile, AA will accept only a minimal number of sophisticated, but not accredited investors. T h e re f o re, if you do not meet the definition of an “accredited investor,” you may not qualify for membership.

2.2 ⁄ I understand that AA is not a venture fund, investment bank, broker/dealer, investment clearinghouse, investment portal, or any other form of investment advisor or otherwise, and is not registered with the Securities and Exchange Commission or any state securities commission. AA does not provide advice, recommendation, or any other indication of appropriateness or inappropriateness for a particular investment. AA does not endorse any investment opportunity and makes no independent investigation to verify information provided by companies submitting to AA for presentation or otherwise, and makes no representation or warranty regarding the same.

⁄ I must conduct my own analysis and due diligence to determine the appropriateness of any investment I make in any company to which I am introduced through AA. As a result, I recognize and agree that neither AA nor its representatives or agents are responsible or liable for any investment decision I make as a result of being a member of AA. The choice to use and the manner of utilization of information and knowledge gained through AA is my individual and personal choice.

⁄ I understand that any purchase of equity or other investment transaction shall be with the respective company, without involvement of, or participation by AA.

⁄ I understand that AA meetings are not an offer to sell or solicitation to buy any security by AA or any other entity. ⁄ I agree to pay the annual membership dues as set by AA.

2.3 MEMBERSHIP CODE OF CONDUCT:

⁄ I will conduct myself in a professional manner at all times. ⁄ I will respect the privacy of other members and not provide their name to any third party without their permission. ⁄ I will keep membership information confidential.

⁄ I understand and recognize that AA meetings and communications are focused on investment pursuits and will not solicit another member for business.

⁄ I will disclose to the group any relationship I have or may have with a presenting company, including any personal gain I may receive from the company.

D I S C L A I M E R :

AA is not a venture fund, an investment bank, a broker dealer, investment clearing-house, or an investment advisor, but rather a forum in which investors may be educated on aspects of investment and business, as well as introduced to companies for possible investment. AA is not registered with the Securities Exchange Commission or any state securities commission. Each member of AA is responsible for his or her own investment decisions, and AA is not recommending any particular company for investment. All investments in entrepreneurial companies involve a high degree of risk, and investors should be able to bear the risk of complete financial loss. The choice to use and manner of utilization of information and knowledge gained through AA is each member’s individual and personal choice. No guidance shall be given, nor shall any person affiliated with AA (or AA itself) be responsible for an individual member’s use of the information, investment decision, or the results of any investment. AA does not conduct any investigation to verify the factual information submitted to potential investors by individual entrepreneurs. Hence, AA makes no representations or warranties regarding these companies. Investors must conduct their own due diligence and negotiate the terms of any investment they elect to make.

2.4 Please fo r w a r d with your application (pre f e r ably in electronic form) to:

Angels Anonymous 1234 Main Street Investor City, MI 55555 Email: [email protected]

Read, understood, and agreed to by:

______Submitting Applicant Member

Please submit this membership agreement with annual membership dues of $ ______. Please make the check payable to Angels Anonymous, or complete the credit card information below. Your check will not be cashed nor credit card charged unless and until your application for membership has been accepted:

Payment:

Check ______Visa ______M/C ______Card # ______Exp. ______

Complete membership submission includes:

⁄ Completed membership agreement ⁄ Completed membership survey ⁄ Payment

2.5 A P P E N D I X 3 A N G E L S A N O N Y M O U S 1 M E M B E R S H I P S U R V E Y

Angels Anonymous (AA) is keenly interested in providing members with maximum benefit, which is aligned with member interests. One of the few ways we have to better understand these interests is to conduct membership surveys and carefully review the results for trends, such as: 1. investment interests; 2. need for expertise among membership; and 3. membership skills which may be valuable to the group as well as portfolio companies. Individual data will be treated confidentially and will not be shared internally or externally; only selected AA Board members will be privy to individual responses. The survey results may be used in aggregate to present AA as an entity to venture capitalists, businesses, and the media for the purpose of securing high-quality deal flow, membership, and public relations.

COMPLETION OF THIS SURVEY IS A CONDITION OF MEMBERSHIP, NEW OR RENEWING

1. What is your membership status? ■ New ■ Renewing

2. Have you ever been an angel investor? ■ No ■ Yes a. If yes, how long? _____ year(s) b. If yes, how many companies have you invested in as an angel investor? _____ (number)

3. In what industry(s) do you have professional experience? (check all that apply) ■ Health care ■ Telecommunications ■ Media ■ Manufacturing ■ Environment ■ Biotechnology ■ Business/Financial ■ Energy ■ E-Commerce ■ Industrial ■ Software ■ Consumer Products ■ Agriculture ■ Hardware ■ Semiconductor Other: ______

4. What business skills/expertise do you have? (check all that apply) ■ Senior management ■ Board member ■ Operations ■ Marketing ■ Sales ■ Research and development ■ Financial services ■ Strategic planning ■ Business plan development ■ Employee benefits ■ Insurance ■ Legal ■ Public relations ■ Infrastructure ■ Accounting

5. Have you ever been a company founder or officer? (check all that apply) ■ Founder ■ CEO ■ President ■ VP – R&D ■ CFO ■ CIO ■ COO ■ VP – Sales and Marketing

1 “Angels Anonymous” is a fictitious angel group and is merely a name used 3.1 for example purposes. IF YOU ANSWERED YES TO QUESTION 2, PLEASE COMPLETE THE FOLLOWING QUESTIONS

6. As an angel investor, what is the typical stage a company is in at the time of your first investment? (give percent for each, totaling 100%) Start-up/seed _____% Early stage _____% Expansion _____% Later stage _____% Mezzanine to IPO _____% Public _____%

7. As an angel investor, what is the typical relationship you have with portfolio companies? (check all that apply) ■ Board member ■ Advisor/mentor ■ Officer ■ Employee ■ Consultant ■ Passive ■ Other: ______

8. As an angel investor, what has been your typical investment range? (give percent for each, totaling 100%) Under $5,000 _____% $5,000 to $10,000 _____% $10,000 to $25,000 _____% $25,000 to $50,000 _____% $50,000 to $100,000 _____% $100,000 to $500,000 _____% $500,000 to $1 Million _____% More than $1 Million _____%

9. If a renewing AA member, have you invested in any AA presenting companies? ■ No ■ Yes If yes, which company(s)? ______If no, why not? ______

10. What is your preferred form of investment? (rank with 1 highest) Equity _____ Debt _____ Combination _____ Case by case _____

11. What is your general expectation on length of time until return on investment? ■ Less than 1 year ■ 1 to 3 years ■ 3 to 5 years ■ More than 5 years

12. In what industries have you invested? (check all that apply) ■ Health care ■ Telecommunications ■ Media ■ Manufacturing ■ Environment ■ Biotechnology ■ Business/Financial ■ Energy ■ E-Commerce ■ Industrial ■ Software ■ Consumer Products ■ Agriculture ■ Hardware ■ Semiconductor Other: ______

13. What has been your historical angel investment rate of return? ■ Negative ■ 0% to 10% ■ 10% to 30% ■ 30% to 50% ■ 50% to 100 ■ 100% to 200% ■ More than 200%

14. What do you enjoy about being part of AA or any angel group? (rank all that apply, with 1 highest) Deal flow _____ Education _____ Camaraderie/social _____ Joint due diligence _____ Meeting companies _____ Shared expertise _____ Administrative support _____ Professional support _____ Guest speakers _____ Other _____

3.2 15. How would you rate your overall satisfaction with AA? _____ 1 – 5 (1 highest)

16. How might we improve AA and your membership experience?

______

______

______

______

______

______

______

Name: ______

Thank you for completing this survey.

3.3 A P P E N D I X 4 A N G E L I N V E S T O R E D U C A T I O N P R O G R A M A G E N D A

TOPIC CONTENT MATERIALS I Introduction: 1. What is an “angel investor?” ⁄ Regulation D A. What is Angel Investing? a. Historically, “angels” were individuals who ⁄ Partial reprints from selected financed Broadway productions materials on angel investing b. Accredited Investor under the SEC rules ⁄ Case studies and regulations: ⁄ Individual annual income of $200,000 or joint of $300,000 ⁄ Net worth of $1,000,000 c. Angel investing statistics: ⁄ Funding gap ⁄ Angels invest more per year than VCs d. Characteristics of an angel investor: ⁄ Invest locally, desiring to give back to their community and prefer to be close to their investments ⁄ Often successful entrepreneurs ⁄ Looking for different investment model ⁄ Interested in a return on investment ⁄ Typically early stage before venture financing or with VC financing 2. Why be an Angel Investor? a. S i g n i f ic a nt possible upside: In re c e n t years, VC investme nts have boasted high re t u r n s b. Possible involvement in company c. Helping entrepreneurs: rewarding 3. Why not be an angel investor? a. High risk b. Invest only what you can lose c. Stressful 4. Options for angel investing a. Independently b. Angel organizations and structure c. Relationship with company

4.1 TOPIC CONTENT MATERIALS B. Deal Flow a. Angel group members b. O t h er angel networks and investme nt gro u p s c. Investment forums ⁄ Generally screened so “best of breed” ⁄ Industry/technology focused, or just early stage ⁄ Interact and learn from experienced angel investors d. Venture capitalists e. Investment bankers f. Professionals: lawyers, accountants, bankers g. Professional/business journals h. Internet II Due Diligence: a. How and when to use consultants and ⁄ Due diligence checklists A. The Process other third parties ⁄ Due diligence request letter b. P rocess: What to ask; how to ask; when to ask ⁄ List of independent analysis c. I nt e r net searc h i n g; Fede ral and state searc he s resources d. Expectations e. Sources for market analysis f. Sources of comparables: ⁄ Recent IPOs (10Ks, annual reports) ⁄ Recent companies funded in this space ⁄ Venture One, Edgar, investment banks ⁄ Verify financial model via comparables B. Governance/Business Structure a. What are the corporate structural options ⁄ Table comparison ex p l a i n i ng and the advantages and disadvantages of d i f f e re nt attributes of each each from an investor’s perspective? s t r u c t u r e (tax, share ho l der lia b i l i t y, C corp. v. S corp. v. LLC v. LP o w n ership re s t r ic t io n s, etc. ) b. Board of directors and advisory boards ⁄ Sample capitalization table c. Internal structure showing various types of d. Shareholder structure and options ownership and shareholder status e. Typical ownership percentages for founders, ⁄ Representative documents key management, etc. ⁄ Example dilution tables f. What dilution means and how to calculate g. Various liquidity options h. Founder share allocations and vesting

4.2 TOPIC CONTENT MATERIALS B. G overnance/Business Structure i. Organizational structure: options ( c o nt i nu e d ) j. Option plans: what are they and importance k. Dilution upon investment C. Financials a. How to read them ⁄ Sample financials b. What to look for ⁄ Typical assumptions c. GAAP basics ⁄ Valuation options d. Valuations e. Financial assumptions and revenue sources D. Market a. Ma r ket-size assessme nts and questio ns to ask ⁄ Sample market plan b. Competitive assessme nts and questio ns to ask ⁄ List of market-information sources E. Management a. How to determine if the team fits the ⁄ List of management attributes to company consider b. What makes a good team? ⁄ List of key management positions c. How to conduct interviews and reference ⁄ List of industry-specific needs checks ⁄ Questions for employee and d. How to analyze management receptiveness reference interviews to input and flexibility F. Intellectual Property a. How to conduct a technology ⁄ Technology audit checklist assessment/audit ⁄ IP vignettes on patents, b. The basics of intellectual property copyright and trademark c. How to determine if adequate systems in ⁄ List or samples of company place to identify and protect IP IP-protection documents such d. How to use technology experts for analysis as employee confidentiality and inventions agreement ⁄ IP decision process and procedure G. Operations a. Components of a good operations plan ⁄ Sample plan b. R e l a t io n ship to fina nc i als and ma r ke t i n g plan

4.3 TOPIC CONTENT MATERIALS III Term Sheets a. What is a private placement? ⁄ Example Term Sheet (annotated) b. What is the investment process? ⁄ Definitions glossary c. What should one expect? ⁄ Case Studies d. What are deal-structure options? ⁄ Common vs. preferred ⁄ Rights, preferences, and privileges e. Negotiating term sheets ⁄ Mock negotiations IV After the Investment a. Level of Involvement ⁄ Monitoring or participating ⁄ Relationship to investment amount ⁄ Individual vs. group investment ⁄ Potential liabilities for board positions b. What You Want ⁄ Information Rights (financials, annual reports, business plans) ⁄ Ability to attend Board meetings

4.4 A P P E N D I X 5 G R O U P F I N A N C E S : R E V E N U E S A N D E X P E N S E S W O R K S H E E T *

REVENUES MONTHLY BUDGET ANNUAL BUDGET

Membership dues

Venture capital member dues

Sponsorships

Company Application Fees

Presenter Fees

Endowment/donations – 501(c)(3) only

Events

Publications

In-kind contributions/sponsorships (with corresponding expense coverage noted)

Total Revenues

EXPENSES** MONTHLY BUDGET ANNUAL BUDGET

Manager/Executive Director and/or administrative support (salary plus possible benefits)

Web site development/maintenance

Meetings

Member relations and communications/correspondence

Public relations

Office expenses

Programs/events

Total Expenses

* Modified balance sheet to show only revenues and expenses **See Table 11 in the Guidebook for possible expenses and for expanded 5.1 explanation and discussion of possible expense categories and range of costs A P P E N D I X 6 A N G E L S A N O N Y M O U S 1 F U N D I N G A P P L I C AT I O N 2

[Note: Company applications should be limited to an executive summary or response to specific questions. Accepting entire business plans can be an exercise in futility as business plans can often exceed 30 to 40 pages, in addition to attachments. Members seldom have the time or patience to read through numerous, lengthy business plans, and often the essential information needed for this initial screening step is not readily appare n t in a large document.

You should also have a page limit for the company application. Requiring answers to specific questions, as opposed to accepting executive summaries, gives greater assurance of receiving all information your scre e n i n g committee desires in reviewing applications, but you risk losing the unique story-telling quality that an executive s u m m a r y has, which often tells you much about management style and communication skills. Additionally, some companies will not want to take the time (or have the time) to answer a series of questions, and these are often the “hot deals” that do not need to go through additional processes to raise money. The brevity re q u i rement may seem harsh, but through experience, the companies able to clearly articulate their mission, product, market, and f u t u re in five pages or less most likely have the greatest chance for success.]

Please submit your executive summary of NO MORE THAN FIVE PAGES (including attachments, appendices and exhibits), which contains information on the subjects identified below. Materials beyond the five-page limit will not be reviewed or considered. The list below is not intended to suggest any particular order of inform a t i o n , but rather the entre p reneur should consider the arrangement best suited for describing his/her company.

1 “Angels Anonymous” is a fictitious angel group and is merely a name used for example purposes. 2 Note: The submission process described in this document is for angel groups in which members select presenting companies through a screening committee structure. If your group is manager led, your manager will likely do screening, which can facilitate receiving more information from companies and provide for a more intensive up-front review process. As discussed in the Guidebook, MBA students can also be valuable in 6.1 conducting initial screening of applicant companies. SUBMISSION CONTENT:

⁄ The Company ⁄ History, including accomplishments to date ⁄ Mission

⁄ Product(s)/Services ⁄ Description of product(s)/services ⁄ Ownership ⁄ Development stage ⁄ Timing of, and process to, commercialization ⁄ Unique attributes and opportunities

⁄ Market ⁄ Size and definition ⁄ Industry trends ⁄ Needs for product(s)/services ⁄ Customers ⁄ Sales/distribution plan ⁄ Necessary partnerships and status ⁄ Competition ⁄ Comparative analysis, including key features and benefits ⁄ Competitive advantage/market differentiators ⁄ Barriers to entry for competitors and company ⁄ Management ⁄ Experience of all senior management, including previous start-ups ⁄ Previous experience working together ⁄ Needs/key vacancies ⁄ Board of Directors ⁄ Advisors

6.2 ⁄ Financials ⁄ Founder’s investment ⁄ Fully-diluted capitalization table (i.e., including options, warrants, and debt) ⁄ Summary projected financials (one and three to five years) ⁄ Funding needs for this round and subsequent rounds ⁄ Use of funds ⁄ Exit strategy and timing ⁄ Business milestones for next six months and next two years

SUBMISSION PROCESS :

⁄ All executive summaries received by the 5th of the month3 will be considered for presentation at the member investment meeting held in the same month. Any submissions after the 5th of the month will be held for the following month’s review and consideration. Companies must submit executive summaries on-line through the Web site at www.angelsanonymous.com or directly to [email protected].

⁄ Submissions must be accompanied by a payment of the processing fee of $100, which is payable on-line at www.angelsanonymous.com. Companies failing to make such payment will not be considered by the screening committee.

⁄ All executive summaries are posted under a members-only section of AA’s Web site and will remain posted for approximately 120 days.

⁄ The screening committee will consider all timely filed and completed submissions and will inform selected companies by the 12th of each month.4 Non-selected companies will be informed by the 15th of each month and will receive standardized feedback from the screening committee.

⁄ Selection criteria are based on review of each executive summary against a screening matrix, a copy of which is available on the AA Web site.

3 Should any date fall on a Saturday, Sunday or holiday, the date will be extended to the next business day. 4 Note: An additional step you may wish to consider is selection of semi- finalists, who are then personally interviewed to make the final selection of 6.3 p resenting companies. This process works well for manager-led angel gro u p s . ⁄ Selected companies must agree to coaching in preparation for their presentation at the member investment meeting. Coaching sessions will be scheduled at the time of selection notification.

⁄ Materials for Member Investment Meeting: Selected companies must give a PowerPoint or equivalent presentation of no more than 15 minutes in length, followed by a five- to-seven-minute Q&A period. Copies of the presentation must be provided to members at the investment meeting and an electronic copy provided to AA for posting under the members-only section of the AA Web site. Companies may offer other materials at the member investment meeting. Space will be made available for a company display or demonstration immediately prior to, during, and after the investment meeting.

⁄ Neither investment solicitation nor commitment will be made at the member investment meeting, and presenting companies are expected to bring with them information on the timing and location for a follow-on meeting with interested AA members.

⁄ Any questions should be directed to [email protected].

6.4 A P P E N D I X 7 A N G E L S A N O N Y M O U S 1 S C R E E N I N G C O M M I T T E E W O R K S H E E T

Scoring: 1= Unsatisfactory 2= Weak 3= Satisfactory 4= Good 5= Excellent

CATEGORY AND QUESTIONS SCORE General Information Was all requested information submitted? 1 2 3 4 5 Was the overall content understandable and well presented? 1 2 3 4 5 Did the applicant stay within the page-submission requirement? 1 2 3 4 5 Products/Services Are the company product/services adequately described? 1 2 3 4 5 Is the ownership well understood? 1 2 3 4 5 Is it clear that the company owns or has licensed all relevant technology? 1 2 3 4 5 If the company is dependent on patents or other intellectual property ownership rights to succeed, 1 2 3 4 5 has the company obtained such protection or taken all steps to date to obtain such protection? Are there large industry competitors which could engineer around the company’s patents? 1 2 3 4 5 Do the product/services solve a current market issue? 1 2 3 4 5 Are there unique attributes to the product/services which provide market differentiation? 1 2 3 4 5 Is this a single product/service company or a suite of potential products/services applicable to 1 2 3 4 5 more than one market? (1: single/narrow niche to 5: numerous/highly diverse) Market Is the market adequately described? 1 2 3 4 5 Is the market realistic? 1 2 3 4 5 Is there a well-defined marketing plan, including distribution? 1 2 3 4 5 What is the size and scope of the market? 1 2 3 4 5 (1: Less than $10 Million and regional to 5: Greater than $1 Billion and global) Is the market considered a growth market? 1 2 3 4 5 Is the customer base well defined, including compelling reasons for customer purchase? 1 2 3 4 5

1 “Angels Anonymous” is a fictitious angel group and is merely a name used 7.1 for example purposes. CATEGORY AND QUESTIONS SCORE Market (continued) Is there a need for follow-on customer relationships (e.g., maintenance services), and, if so, has this been 1 2 3 4 5 well defined and addressed? Has the company established all necessary partnerships, whether service providers, manufacturers, 1 2 3 4 5 distributors, or third-party developers? Competition Does the company recognize competitors? 1 2 3 4 5 Has the company done a competitive analysis, with attention to key features and benefits? 1 2 3 4 5 Has the company fairly analyzed and compared or contrasted itself with the competition? 1 2 3 4 5 Does the company present a strong and factually based reasoning for its competitive advantage? 1 2 3 4 5 Are you aware of other players in the market that the company has not identified? 1 2 3 4 5 Does the company need a first-mover position? 1 2 3 4 5 If a first-mover position is needed, will the company have adequate financial resources and/or first-to- 1 2 3 4 5 market timing advantage to make this approach succeed? Management 1 2 3 4 5 Does management have adequate experience and expertise to properly build the company? 1 2 3 4 5 Is the management team complete? 1 2 3 4 5 If not complete, does management recognize these needs? 1 2 3 4 5 Has the management worked together before? 1 2 3 4 5 Has management been previously funded? 1 2 3 4 5 Does the Board of Directors include outside directors? 1 2 3 4 5 Does the Board have a diversity of skills and background? 1 2 3 4 5 Does the company have a Board of Advisors? 1 2 3 4 5

7.2 CATEGORY AND QUESTIONS SCORE Financials Has the company provided adequate and understandable current and projected financial statements? 1 2 3 4 5 Are the company’s projections realistic? 1 2 3 4 5 Do the financials show a viable and sustainable revenue model? 1 2 3 4 5 Has the company ade q uately cons ide red all costs associated with de v e l o p i n g and ma r ke t i ng its pro duc t / s e r v ic e s ? 1 2 3 4 5 Has the company articulated the use of raised funds? 1 2 3 4 5 Is the company using the funds to pay off debts? 1 2 3 4 5 (1: More than 50% used for debt reduction or elimination to 5: No use on debt) Has the company considered a reasonable exit strategy? 1 2 3 4 5 Have the founders contributed their own capital into the company? 1 2 3 4 5 Is the company dependent on others for success? (1: Yes, nearly completely to 5: None whatsoever) 1 2 3 4 5 Total Score

Comments:

______

______

______

______

______

______

______

______

7.3 A P P E N D I X 8 I S S U E S T O C O N S I D E R I N D U E D I L I G E N C E

C O R P O R A TE STRUCTURE AND GOVERNANCE (REVIEW DOCUMENTS AND INTERVIEW MANAG E M E N T , BOARD, AND ADV I S O R S )

⁄ What is the company’s corporate structure? C corp., S corp., LLC or LP? Does this model allow for a liquidity event and/or return on investment?

⁄ Is there an exit strategy? ⁄ Is the corporate structure overly complicated? If so, why, and might it be simplified? ⁄ How many existing shareholders? Too numerous, and, if so, why?

⁄ Does the corporate structure fit with the business model? ⁄ Does the corporate structure allow for growth? ⁄ What is the founder share allocation? Do they have a large enough stake to have the incentive to succeed, but not so large as to ignore board and other advisors? Is the founders’ stock vested over time?

⁄ Who is on the board of directors? Do they have the right background for the company? Is there a sufficient number of outside directors? How are board members compensated?

⁄ Does the company have a board of advisors and, if so, who is on the board? Do the advisors actively participate in the company’s development? How are advisors compensated?

⁄ Has the company been involved in any litigation or been threatened with litigation?

⁄ Does the company have all required permits and licenses?

FINANCIAL ASSUMPTIONS AND REVENUE SOURCE S (REVIEW ALL FI NANCIAL DOCUMENTS)

⁄ Has the company completed one-, three- and five-year financial projections? ⁄ Have the financial documents been properly developed according to applicable accounting rules? ⁄ Has the company used an outside, independent accounting firm to compile, review, or audit financials?

8.1 ⁄ How good are the assumptions? (rate of growth, acceptance rate, pricing, multiple revenue streams, costs)

⁄ Are revenues realistic? ⁄ When does the company reach cash flow positive, and what cash requirements will it take to get there? ⁄ Has the company already received funding, and, if so, how much; what are pre-money valuation and terms?

⁄ What are the follow-on funding requirements and sources? Has the company properly anticipated future needs, and is it already working on those?

⁄ Have all tax returns been properly filed?

⁄ What is the company’s debt carry? What are the ratios? ⁄ Is the company’s current valuation aligned with its current stage of development and market potential?

MARKET AS SESSMENT (DO INDEPENDENT MARKET ANALYSIS AND REQUI RE CUSTOMER REFERENCES IF APPLICABLE)

⁄ Does the company’s product or service address a new or existing market? ⁄ Is the product or service platform-based, with the opportunity for additional products or services? Or is this potentially a one-trick pony?

⁄ Does the company have a well-thought-out sales and marketing plan? ⁄ Does the company have key relationships in place, or is it working on the same, with marketing and/or sales part n e r s ?

⁄ Does the company have or need key joint venture relationships? ⁄ Is the company focused on the appropriate market development, or are they trying to do too much at one time? ⁄ Have they chosen the right first market?

⁄ Does their product or service represent a market push or pull? ⁄ What is the potential market size?

8.2 ⁄ Have they conducted thorough market research to support their financial assumptions, revenue model, and v a l u a t i o n ?

⁄ What is their stage of development? Concept, alpha, beta, or shipping? ⁄ If the company has already introduced its product or service into the market, what is the number of current and potential customers?

⁄ What is the length of its sales cycle? ⁄ What are the channels of distribution?

⁄ Does the company’s product or service have a seasonal aspect? ⁄ Is this a stable market and are COGS stable?

COMPETITIVE ARENA (DO INDEPENDENT COMPETITIVE ANALY S I S )

⁄ Who are the company’s competitors? ⁄ Has the company realistically assessed its competitors?

⁄ What is the company’s market differentiator? Is this enough to make them superior to competition from the customer’s perspective?

⁄ Is this a market or product consolidation?

⁄ How entrenched are the competitors? ⁄ What is the financial stability of competitors? ⁄ What does the market share look like?

⁄ How will this company win? ⁄ Has the company done a detailed feature-by-feature analysis?

8.3 M A N A GE MENT TEAM (INTERVIEW ALL TEAM MEMBERS AND KEY EMPLOYEE REFERENCES)

⁄ What is the caliber/pedigree of the team? ⁄ What is the team’s overall track record?

⁄ Do they have the combined requisite skills and experience? ⁄ Do they recognize limitations in management, and are they seeking candidates? ⁄ Is the management open to discussion and suggestions on improvement to their business model?

⁄ Has the management team been previously funded? ⁄ How are management and all other employees being compensated? ⁄ Does the company have an option plan, and have options been granted to all employees? What percentage do the founders have as compared to other key management?

TE CHNOLOGY ASSESSMENT ( M A Y NEED EXPERT OR PROFESSIONAL ASSISTANCE IN TECHNOLOGY ASSESSMENT)

⁄ Do they have market requirements and functional specifications? ⁄ At what stage is development? Concept, alpha, beta, shipping? ⁄ Does the company have any usability studies?

⁄ Does the company have adequate intellectual-property protection? Does it need it? ⁄ Is the company relying on being first to market, rather than on any IP position, for competitive advantage, and is this realistic?

⁄ What is product quality assurance like?

8.4 ⁄ Is it proprietary architecture or open-source code?

⁄ Do they have adequate systems in place to identify and protect IP? ⁄ Who in the company is focused on these issues? ⁄ Has the company properly set up relationships and documentation to ensure ownership of all intellectual property?

⁄ Does the company own all necessary intellectual property through internal development or licenses? ⁄ Do any other companies have potential claims to the IP resulting from previous employment relationships or for any other reason?

O P E R A TIONS

⁄ Does the company have an operating plan or outline of the same if early stage?

⁄ Has the company considered all aspects of operation to successfully launch a product or service? ⁄ Does the operating plan anticipate growth? Is anticipated growth realistic? ⁄ Has the company received any citations or notices of violation?

⁄ For more mature companies, does each division of the company have an operating plan, and are they compatible? ⁄ Does management meet regularly to ensure compliance with plan or make needed adjustments? ⁄ Has the company been able to stay on plan?

⁄ Does the plan take into consideration all cash needs and anticipated cash flow? ⁄ Does the company have an alternative plan if assumptions do not hold, such as for product rollout, cash needs, and market response?

8.5 C O M P A R A B L E S :

⁄ Recent IPOs (10Ks, annual reports) ⁄ Recent companies funded in this space ⁄ Third-party (including government) databases, reports, publications, and market analysis

⁄ Comparable financial models

W H A T TO WATCH OUT FOR: ⁄ U n r ealistic valuation (or revenue model) ⁄ Affects percentage ownership ⁄ Affects possible subsequent rounds ⁄ May end up with “down-round” on next financing ⁄ Complicated investment terms ⁄ Preferred fine, but be careful of other complicated features such as rights of first refusal; onerous liquidation preferences; registration rights; no lock-ups; co-sale

⁄ Heavy debt ⁄ New investment dollars should be used for advancing the company, not for paying old obligations ⁄ Missing key assumptions about market or financial model ⁄ One-trick pony (one-product or -service company ) ⁄ No board per se ⁄ I n e xperienced management ⁄ Poor advisors

8.6 A P P E N D I X 9 D U E D I L I G E N C E C H E C K L I S T T A B L E

The documents and materials itemized below constitute a list of materials which should be reviewed for any financing. Keep in mind that many early-stage companies will not have some or many of these documents, as certain events may not have occurred. Request should be made for all documents or disclosures listed below.

TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS I. General corporate materials (The Company, all subsidiaries, partnerships and joint ventures). A. Business Plan, i nc l u d i ng executive summa r y, ma r ke t a nalysis a nd plan, opera t i o nal plan, and complete f i na nc i a l s. B. Minutes 1. Minutes of stockholders’ meetings, including those of any predecessor corporations. 2. Minutes of board of directors, including those of any predecessor corporations. 3. Minutes of permanent committees of the board, including those of any predecessor corporations. 4. Authorizing resolutions relating to this offering and related transactions. C. Charter Documents 1. Articles or Certificate of Incorporation, as amended to date, including current drafts of pending charter amendments and recapitalization documents. 2. Drafts of documents related to proposed reincorporation. 3. Bylaws, as amended to date. 4. Good standing (and franchise tax board) certificates. 5. List of jurisdictions in which the Company or any of its subsidiaries or affiliates is qualified to do business,

9.1 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS D. Corporate Organization 1. List of officers and directors. 2. Management structure organization chart. 3. Stockholders’ lists (including list of optionees and warrant holders), including number of shares and dates of issuance, and consideration paid. 4. Information regarding subsidiaries, i.e., ownership, date of acquisition of stock and/or assets, all closing binders relating to acquisitions. 5. Information regarding joint ventures or partnership, i.e., partners, date of formation, all closing binders relating to joint ventures or partnerships. 6. Agreements relating to mergers, acquisitions, or dispositions by the Company of its subsidiaries or affiliates of companies, significant assets or operations involving the Company or any of its subsidiaries or affiliates since inception, including those of any predecessor or subsidiary corporations. E. Capital Stock 1. Stock records, stock ledgers and other evidence of securities authorized and issued. 2. Agreements relating to the purchase, repurchase, sale or issuance of securities, including oral commitments to sell or issue securities. 3. Agreements relating to voting of securities and restrictive share transfers. 4. Agreements relating to preemptive or other preferential rights to acquire securities and any waivers thereof. 5. Agreements relating to registration rights.

9.2 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS 6. Evidence of qualification or exemption under applicable federal and state blue sky laws for issuance of the Company’s securities. 7. D o c u me nts re l a t i n g to any conversion, re c a p i t a l i z a t io n , re o rg a n i z a t ion, or sig n i f ic a nt re s t r u c t u r i ng of the Company. II. Litigation A. Any litigation, claims, and proceedings settled or concluded, including those of any predecessor corporations and subsidiaries. B. Any litigation, claims, and proceedings threatened or pending. Please include potential litigation—e.g., employees who may be in breach of non-compete agreements with prior employers. C. Any litigation involving an executive officer or director, including executive officers or directors of predecessor corporations and subsidiaries, concerning bankruptcy, crimes, securities law, or business practices. D. A ny cons e nt de c re e s, injunc t io ns, judg me nt s , other de c re e s or orde r s, settleme nt agre e me n t s, or similar ma t t e r s. E. All attorneys’ letters to auditors, including those of any predecessor corporation and subsidiaries. III. Compliance with Laws A. Any citations and notices received from government agencies, including those of any predecessor or subsidiary corporations, or with continuing effect from an earlier date. B. Any pending or threatened investigations and governmental proceedings.

9.3 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS C. All material governmental permits, licenses, etc., of the Company presently in force, together with information regarding any such permits, licenses, etc., which have been canceled or terminated, required to carry out the business or operations of the Company or its subsidiaries or affiliates, including such permits, licenses, etc. required by foreign, federal, provincial, or local authorities, and any evidence of exemption from any such permit or license requirement. D. All documents filed with the SEC or any state or foreign securities regulatory agency, if any. E. Any material reports to and correspondence with any government entity, municipality or government agencies, including the EPA and OSHA, including those of any predecessor corporations or subsidiaries. IV. Employee Matters (Including items regarding any predecessor or subsidiary or affiliated corporations and all items presently in force and drafts of any pending amendments or new items) A. Employee agreements. B. Consulting contracts. C. Employee benefit and profit-sharing plans, including stock option, stock purchase, deferred compensation, and bonus plans or arrangements. D. All other employee compensation, bonus, incentive, retirement, benefit (e.g., Life or health insurance, medical reimbursement plans, etc.), or similar plans. E. Employee Confide n t iality and Pro p r ietary Rig hts Ag re e me nt F. Officers and directors questionnaires. G. Contracts with unions and other labor agreements.

9.4 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS H. Loans to and guarantees for the benefit of directors, officers or employees. I. “Key person” insurance policies. J. Listing of employees by office and department. K. Affiliation agreements with advertising agencies or public relations firms. L. Stock ownership of directors and of the five most- highly compensated officers. V. Real Property A. Deeds. B. Leases of real property. C. Other interests in real property. D. Any documents showing any certification of compliance with, or any deficiency with respect to, regulatory standards of the Company’s or any of its subsidiaries’ or affiliates’ facilities. E. Financing leases and sale and lease-back agreements. F. Conditional sale agreements. G. Equipment leases. VI. Intellectual Property Matters A. List of all foreign and domestic patents, patent applications, copyrights, patent licenses and copyright licenses held by the Company. B. List of any trademarks, trademark applications, trade names, or service marks. C. C la i ms of infringe m e nt or misappro p r ia t ion of othe r s ’ p a t e nt s, copyrig ht s, tra de secre t s, or other pro p r ietary rig ht s.

9.5 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS D. Copies of all agreements in-licensing or acquiring any technology, including without limitation software licenses, patent licenses, or other technology licenses, or any development or joint-development agreements. E. Copies of all agreements out-licensing or selling any technology, including without limitation any software licenses, patent licenses, or other technology licenses, or any distribution, OEM, VAR or sales-representative agreements. VII. Debt Financing A. All debt instruments, credit agreements, and guarantees entered into by the Company, including lease financing, which are currently in effect. B. All material correspondence with lenders, including all compliance reports submitted by the Company or its accountants. C. Any loans and guarantees of third-party obligations. D. A ny agre e me n ts re s t r ic t i ng the payme n t of cash divide n d s. VIII. Other Agreements A. Marketing agreements. B. Management and service agreements. C. Forms of secrecy, confidentiality, and nondisclosure agreements. D. Contracts outside the ordinary course of business. E. Indemnification contracts and similar arrangements for officers and directors. F. Ag re e m e nts with of f ic e r s , dire c t o r s, and affiliated partie s. G. Any agreements with competitors.

9.6 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS H. A ny agre e me nts with go v e r n me ntal age nc ies or ins t i t u t i o ns. I. Any agreements restricting the Company’s right to compete or other agreements material to the business. J. A ny ma t e r i al ins u r a nce arra nge me nts (inc l u d i ng pro p e r t y da ma ge, third-party lia b i l i t y, and key employee ins u ra n c e ) . K. Agreements requiring consents or approvals or resulting in changes in rights in connection with change-of- control transactions. IX. Financial Information A. Audited/Unaudited financial statements, including those of any predecessor corporations. B. Interim financial statements. C. Budget plan, including revisions to date with respect to the budget plan for the current fiscal year for the Company and its subsidiaries and affiliates. D. The Company’s long-range strategic plan, any other documents concerning its long-range plans, and any information concerning the Company’s compliance therewith. E. Disclosure documents used in private placements of the Company’s or any of its subsidiaries’ or affiliates’ securities, or institutional- or bank-loan applications since inception. F. Any other material agreements with creditors. G. Significant correspondence with independent public accountants, including management letters. H. Any reports, studies and projections prepared by management on the Company’s or its subsidiaries’ or affiliates’ business, financial condition, or planned operations, including business plan.

9.7 TITLE OF SECTION DOCUMENTS REQUESTED SHOULD DATE DATE REVIEWER’S COMMENTS AND SUBSECTION HAVE RECEIVED DELIVERED INITIALS I. Any reports and studies prepared by outside consultants on the Company’s or its subsidiaries’ or affiliates’ business or financial condition. J. Reports and materials prepared for the Company’s board of directors or a committee thereof. K. Contracts with investment bankers and brokers. X. Tax Matters A. Federal, state and local tax returns, including those of any predecessor corporations. B. Audit adjustments proposed by the IRS. XI. Acquisitions/Divestitures A. Acquisitions or divestitures (including related documentation). B. Current plans or negotiations relating to potential acquisitions or divestitures. XII. Public Relations A. Annual reports and other reports and communications with stockholders, employees, suppliers, and customers. B. Advertising, marketing, and other selling materials. XIII. Press Releases and Clippings A. Analyst reports. XIV. Miscellaneous A. Supply copies of all market research or marketing studies concerning the Company’s business conducted. B. Significant agreements currently in draft stage.

9.8 A P P E N D I X 1 0 G L O S SAR Y OF TERMS RELATED TO VENTURE CAPITAL AND OTHER PRIVATE EQUITY OR DEBT FINANCING

401(K) Plan: A type of qualified retirement plan in which employees make salary-reduced, pre-tax contributions to an employee trust. In many cases, the employer will match employee contributions up to a specified level.

- A -

Ac c r edited Inve s t o r : Rule 501 of the SEC regulations defines an individual accredited investor as: “Any natural person whose individual net worth or joint net worth with that person’s spouse at the time of his purchase exceeds $1,000,000”; OR “Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.” For the complete definition of “accredited investor,” see the SEC web site.

Accrued Intere s t : The interest due on preferred stock or a bond since the last interest payment was made.

AC R S : Accelerated Cost Recovery System. The IRS-approved method of calculating depreciation expense for tax purposes. Also known as Accelerated Depreciation.

A D R : American Depositary Receipt (ADRs). A security issued by a U.S. bank in place of the foreign shares held in trust by that bank, thereby facilitating the trading of foreign shares in U.S. markets.

Advisory Board : A group of external advisors to a private equity group or portfolio company. Advice provided varies from overall strategy to portfolio valuation. Less formal than a Board of Directors.

Allocation: The amount of securities assigned to an investor, broker, or underwriter in an offering. An allocation can be equal to or less than the amount indicated by the investor during the subscription process, depending on market demand for the securities.

A m o r t i z a t i o n : An accounting procedure that gradually reduces the book value of an intangible asset through periodic charges to income.

A M T : Alternative Minimum Tax. A tax designed to prevent wealthy investors from using tax shelters to avoid income tax. The calculation of the AMT takes into account tax-preference items.

10.1 Angel Financing: Capital raised for a private company from independently wealthy investors. This capital is generally used as seed financing.

Angel Fund: A formal or informal assemblage of active angel investors who cooperate in some part of the investment process. Key characteristics of an angel group are: control by member angels (who manage the entity or have control over the entity’s managers), and collaboration by member angels in the investment process.

Angel Inve s t i n g : An angel investor is an individual who makes direct investments of personal funds into a venture , typically early-stage businesses. Because the capital is being invested at a risky time in a business venture, the angel must be capable of taking a loss of the entire investment, and, as such, most angel investors are high-net-wort h individuals. These individuals are nearly always “accredited investors” as defined under the Securities Act of 1933.

- B -

Balance Sheet: A condensed financial statement showing the nature and amount of a company’s assets, liabilities, and capital on a given date.

B a n k r u p t c y : An inability to pay debts. Chapter 11 of the bankruptcy code deals with reorganization, which allows the debtor to remain in business and negotiate for a restructuring of debt.

Bear Hug: An offer made directly to the Board of Directors of a target company. Usually made to increase the pressure on the target with the threat that a tender offer may follow.

Best Efforts: An offering in which the investment banker agrees to distribute as much of the offering as possible and return any unsold shares to the issuer.

Blue Sky Laws : A common term that refers to laws passed by various states to protect the public against securities fraud. The term originated when a judge ruled that a stock had as much value as a patch of blue sky.

Book Va l u e : Book value of a stock is determined from a company’s balance sheet by adding all current and fixed assets and then deducting all debts, other liabilities, and the liquidation price of any preferred issues. The sum arrived at is divided by the number of common shares outstanding, and the result is book value per common share.

Bond: Specific type of debt instrument most commonly sold by government entities.

10.4 Bridge Financing: A limited amount of equity or short-term debt financing typically raised within 6-18 months of an anticipated public offering or private placement meant to “bridge” a company to the next round of financing.

Burn Out / Cram Dow n : Extraordinary dilution, by reason of a round of financing, of a non-participating investor’s percentage ownership in the issuer.

Burn Rate: The rate at which a company expends net cash over a certain period, usually a month.

Business Development Company (BDC): A vehicle established by Congress to allow smaller, retail investors to p a rticipate in and benefit from investing in small private businesses as well as the revitalization of larger private c o m p a n i e s .

Business Judgment Rule: The legal principle that assumes the board of directors is acting in the best interests of the shareholders unless it can be clearly established that it is not. If the board was found to violate the business judgment rule, it would be in violation of its fiduciary duties to the shareholders.

Business Plan: A document that describes the entrepreneur’s idea, the market problem, proposed solution, business and revenue models, marketing strategy, technology, company profile, competitive landscape, as well as financial data for coming years. The business plan opens with a brief executive summary, most probably the most important element of the document due to the time constraints of venture capital funds and angels.

- C -

C A GR: Compound Annual Growth Rate. The year-over-year growth rate applied to an investment or other aspect of a firm using a base amount.

Call Option: The right to buy a security at a given price (or range) within a specific time period.

Capital (or Assets) Under Management: The amount of capital available to a fund-management team for venture investments.

Capital Gains: The difference between an asset’s purchase price and selling price, when the selling price is greater. Long-term capital gains (on assets held for a year or longer) are taxed at a lower rate than ordinary income.

10.3 Capitalization Table: Also called a “Cap Table,” this is a table showing the total amount of the various securities issued by a firm. This typically includes the amount of investment obtained from each source and the securities distributed — e.g., common and preferred shares, options, warrants, etc. — and respective capitalization ratios.

Capitalize: To record an outlay as an asset (as opposed to an expense), which is subject to depreciation or amortization.

Carried Interest or “Carry”: The portion of any gains realized by the fund to which the fund managers are entitled, generally without having to contribute capital to the fund. Carried interest payments are customary in the venture capital industry, in order to create a significant economic incentive for venture capital fund managers to achieve capital gains.

Cash Po s i t i o n : The amount of cash available to a company at a given point in time.

Chapter 11: The part of the Bankruptcy Code that provides for reorganization of a bankrupt company’s assets.

Chapter 7: The part of the Bankruptcy Code that provides for liquidation of a company’s assets.

Claim Dilution: A reduction in the likelihood that one or more of the firm’s claimants will be fully repaid, including time value of money considerations.

C l a w b a c k : A clawback obligation re p resents the general part n e r’s promise that, over the life of the fund, the managers will not receive a greater share of the fund’s distributions than they bargained for. Generally, this means that the general partner may not keep distributions re p resenting more than a specified percentage (e.g., 20%) of the f u n d ’s cumulative profits, if any. When triggered, the clawback will re q u i re that the general partner re t u rn to the f u n d ’s limited partners an amount equal to what is determined to be “excess” distributions.

Closed-end Fund: A type of fund that has a fixed number of shares outstanding, which are offered during an initial subscription period, similar to an initial public offering. After the subscription period is closed, the shares are traded on an exchange between investors, like a regular stock. The market price of a closed-end fund fluctuates in response to investor demand as well as changes in the values of its holdings or its Net Asset Value. Unlike open-end mutual funds, closed-end funds do not stand ready to issue and redeem shares on a continuous basis.

C l o s i n g : An investment event occurring after the required legal documents are implemented between the investor and a company and after the capital is transferred in exchange for company ownership or debt obligation.

10.4 C o - i n v e s t m e n t : The syndication of a private equity financing round or an investment by an individual (usually general partners) alongside a private equity fund in a financing round.

Collar Ag r eement: Agreed-upon adjustments in the number of shares offered in a stock-for-stock exchange to account for price fluctuations before the completion of the deal.

Committed Capital: The total dollar amount of capital pledged to a private equity fund.

Common Stock: A unit of ownership of a corporation. In the case of a public company, the stock is traded between investors on various exchanges. Owners of common stock are typically entitled to vote on the selection of directors and other important events and in some cases receive dividends on their holdings. Investors who purchase common stock hope that the stock price will increase so the value of their investment will appreciate. Common stock offers no performance guarantees. Additionally, in the event that a corporation is liquidated, the claims of secured and unsecured creditors and owners of bonds and preferred stock take precedence over the claims of those who own common stock.

C o n v e r sion Ratio: The number of shares of stock into which a convertible security may be converted. The conversion ratio equals the par value of the convertible security divided by the conversion price.

C o n v ertible Security: A bond, debenture or preferred stock that is exchangeable for another type of security (usually common stock) at a pre-stated price. Convertibles are appropriate for investors who want higher income, or liquidation-preference protection, than is available from common stock, together with greater appreciation potential than regular bonds offer. (See Common Stock, Dilution, and Preferred Stock).

C o n v ertible [Note] [Debenture ] : Debt instrument that automatically or voluntarily converts to some other security, either debt or equity.

C o n v ertible Pre f e r r ed Stock: Preferred stock that may be converted into common stock or another class of preferred stock, either voluntarily or mandatory.

C o r p o r ate Charter: The document prepared when a corporation is formed. The Charter sets forth the objectives and goals of the corporation, as well as a complete statement of what the corporation can and cannot do while pursuing these goals.

10.5 C o r p o r ate Resolution: A document stating that the corporation’s board of directors has authorized a particular individual to act on behalf of the corporation.

C o r p o r ate Venturing: Venture capital provided by [in-house investment funds of] large corporations to further their own strategic interests.

C o r p o r ation: A legal, taxable entity chartered by a state or the federal government. Ownership of a corporation is held by the stockholders.

C o venant: A protective clause in an agreement.

C u m u l a t i v e Pre f e r r ed Stock: A stock having a provision that if one or more dividend payments are omitted, the omitted dividends (arrearage) must be paid before dividends may be paid on the company’s common stock.

C u m u l a t i v e Voting Rights: When shareholders have the right to pool their votes to concentrate them on an election of one or more directors rather than apply their votes to the election of all directors. For example, if the company has 12 openings to the Board of Directors, in statutory voting, a shareholder with 10 shares casts 10 votes for each opening (10x12 = 120 votes). Under the cumulative voting method however, the shareholder may opt to cast all 120 votes for one nominee (or any other distribution he might choose).

- D -

D e b e n t u r e : A debt instrument; basically the same as a Promissory Note.

D e b t : Any obligation by one person to pay another. May be a primary (direct) obligation as in a Note, or a secondary (contingent) obligation as in a guaranty.

Debt Instrument: Any instrument evidencing the obligation of the maker to pay the holder of the debt instrument. Includes Bonds, Debentures and Notes of all kinds.

D e f i c i e n c y Letter: A letter sent by the SEC to the issuer of a new issue regarding omissions of material fact in the registration statement.

Demand Registra t i o n : Resale registration that gives the investor the right to require the Company to file a Registration Statement registering the resale of the securities issued to the investor in a private offering.

10.6 Demand Rights: Contemplate that the company must initiate and pursue the registration of a public offering including, although not necessarily limited to, the shares proffered by the requesting shareholder(s).

D e p r e c i a t i o n : An expense recorded to reduce the value of a long-term tangible asset. Since it is a non-cash expense, it increases free cash flow while decreasing the amount of a company’s reported earnings.

D i l u t i o n : A reduction in the percentage ownership of a given shareholder in a company caused by the issuance of new shares.

Dilution Pro t e c t i o n : Mainly applies to convertible securities. Standard provision whereby the conversion ratio is changed accordingly in the case of a stock dividend or extraordinary distribution to avoid dilution of a convertible bondholder’s potential equity position. Adjustment usually requires a split or stock dividend in excess of 5% or issuance of stock below book value. Share Purchase Agreements also typically contain anti-dilution provisions to protect investors in the event that a future round of financing occurs at a valuation that is below the valuation of the current round.

D i r ector: Person elected by shareholders to serve on the board of directors. The directors appoint the president, vice president and all other operating officers, and decide when dividends should be paid (among other matters).

D i s c l o s u r e Document: A booklet outlining the risk factors associated with an investment.

D i v e r s i f i c a t i o n : The process of spreading investments among various types of securities and various companies in different fields.

D i v i d e n d : The payments designated by the Board of Directors to be distributed pro-rata among the shares outstanding. On preferred shares, it is generally a fixed amount. On common shares, the dividend varies with the fortune of the company and the amount of cash on hand and may be omitted if business is poor or if the Directors determine to withhold earnings to invest in capital expenditures or research and development.

D r ag-Along Rights: A majority shareholders’ right, obligating shareholders whose shares are bound into the shareholders’ agreement to sell their shares into an offer the majority wishes to execute.

Due Diligence: A process undertaken by potential investors — individuals or institutions — to analyze and assess the desirability, value, and potential of an investment opportunity.

10.7 - E -

Early Stage: A state of a company that typically has completed its seed stage and has a founding or core senior management team, has proven its concept or completed its beta test, has minimal revenues, and no positive earnings or cash flows.

E B I T D A: Earnings Before Interest, Taxes, Depreciation, and Amortization. A measure of cash flow calculated as: = Revenue - Expenses (excluding tax, interest, depreciation, and amortization).

EBITDA looks at the cash flow of a company. By not including interest, taxes, depreciation, and amortization, we can clearly see the amount of money a company brings in.

This is especially useful when one company is considering a takeover of another because the EBITDA would cover any loan payments needed to finance the takeover.

Economies of Scale: Economic principle that, as the volume of production increases, the cost of producing each unit decreases.

E l e vator Pitch: An extremely concise presentation of an entrepreneur’s idea, business model, company solution, marketing strategy, and competition delivered to potential investors. Should not last more than a few minutes, or the duration of an elevator ride.

E m p l o yee Stock Option Plan (ESOP): A plan established by a company whereby a certain number of shares is reserved for purchase and issuance to key employees. Such shares usually vest over a certain period of time to serve as an incentive for employees to build long-term value for the company.

E m p l o yee Stock Ownership Plan: A trust fund established by a company to purchase stock on behalf of employees.

Equity: Ownership in the capital of a Company. In corporations, it is called “stock”; in limited partnerships or LLCs, it is called “interests” or “units.”

Equity Kicke r : Option for private equity investors to purchase shares at a discount. Typically associated with mezzanine financings where a small number of shares or warrants are added to what is primarily a debt financing.

10.8 E R I S A : ERISA shall mean the United States Employee Retirement Income Security Act of 1974, as amended, including the regulations promulgated thereunder.

E R I S A Significant Participation Test: A test that is satisfied if the General Partner determines in its reasonable discretion that Persons that are “benefit plan investors” within the meaning of Section (f)(2) of the Final Regulation constitute or are expected to constitute at least 25 percent of the interests of the Limited Partners.

Note that the test is 25% of the interests of all the limited partners, which means 20% (+/-) in the partnership as a whole, taking into account the general partner’s interest.

E x change Ac t : [“34 Act”] Regulates periodic reporting by companies with publicly traded securities, companies with more than 500 shareholders, and brokers and dealers in securities.

E x e r cise price: The price at which an option or warrant can be exercised.

Exit Strategy: A fund’s intended method for liquidating its holdings while achieving the maximum possible return. These strategies depend on the exit climates, including market conditions and industry trends. Exit strategies can include selling or distributing the portfolio company’s shares after an initial public offering (IPO), a sale of the portfolio company, or a recapitalization.

- F -

Final Regulation: An ERISA term, it is the United States Department of Labor’s Final Regulation relating to the definition of “plan assets” in (29 C.F.R. §2510.3-101).

Finder: A person who helps to arrange a transaction.

F l i p p i n g : The act of buying shares in an IPO and selling them immediately for a profit. Brokerage firms underwriting new stock issues tend to discourage flipping and will often try to allocate shares to investors who intend to hold on to the shares for some time. However, the temptation to flip a new issue once it has risen in price sharply is too irresistible for many investors who have been allocated shares in a hot issue.

Form 10-K: This is the annual report that most reporting companies file with the Commission. It provides a comprehensive overview of the registrant’s business.

10.9 Form 10-KSB: This is the annual report filed by reporting “small business issuers.” It provides a comprehensive overview of the company’s business, although its requirements call for slightly less detailed information than required by Form 10-K.

Form S-1: The form can be used to register securities for which no other form is authorized or prescribed, except securities of foreign governments or political sub-divisions thereof.

Form S-4: Type of Registration Statement under which public company mergers and security exchange offers may be registered with the SEC.

Form SB-2: This form may be used by “small business issuers” to register securities to be sold for cash. This form requires less detailed information about the issuer’s business than Form S-1.

Fo u n d e r s’ Share s : Shares owned by a company’s founders upon its establishment.

F r ee cash flow : The cash flow of a company available to service the capital structure of the firm. Typically measured as operating cash flow less capital expenditures and tax obligations.

Full Ratchet Antidilution: The sale of a single share at a price less than the favored investors paid reduces the conversion price of the favored investors’ convertible preferred stock “to the penny.” For example, from $1.00 to 50 cents, regardless of the number of lower-priced shares sold.

Fully Diluted Earnings Per Share : Earnings per share expressed as if all outstanding convertible securities and warrants have been exercised.

Fully Diluted Outstanding Share s : The number of shares representing total company ownership, including common shares and current conversion or exercised value of the preferred shares, options, warrants, and other convertible securities.

Fund Size: The total amount of capital committed by the investors of a venture capital fund.

10.10 - G -

GAAP: Generally Accepted Accounting Principles. The common set of accounting principles, standards, and procedures. GAAP is a combination of authoritative standards set by standard-setting bodies as well as accepted ways of doing accounting.

G e n e r al Partner (GP): The partner in a limited partnership responsible for all management decisions of the partnership. The GP has a fiduciary responsibility to act for the benefit of the limited partners (LPs) and is fully liable for its actions.

Golden Handcuffs: This occurs when an employee is required to relinquish unvested stock when terminating his employment contract early.

Golden Pa r a c h u t e : Employment contract of upper management that provides a large payout upon the o c c u rrenc e of certain control transactions, such as a certain percentage share purchase by an outside entity or when there is a tender offer for a certain percentage of a company’s shares. This is discussed in more detail at the Executive Employment Agre e m e n t .

- H -

Holding Company : A corporation that owns the securities of another, in most cases with voting control.

Holding Pe r i o d : The amount of time an investor has held an investment. The period begins on the date of purchase and ends on the date of sale, and determines whether a gain or loss is considered short term or long term, for capital-gains-tax purposes.

Hot Issue: A newly issued stock that is in great public demand. Technically, it is when the secondary market price on the effective date is above the new issue offering price. Hot issues usually experience a dramatic rise in price at their initial public offering because the market demand outweighs the supply.

H u r dle Rate: The internal rate of return that a fund must achieve before its general partners or managers may receive an increased interest in the proceeds of the fund. Often, if the expected rate of return on an investment is below the hurdle rate, the project is not undertaken.

10.11 - I -

Initial Public Offering (IPO): The sale or distribution of a stock of a portfolio company to the public for the first time. IPOs are often an opportunity for the existing investors (often venture capitalists) to receive significant returns on their original investment. During periods of market downturns or corrections, the opposite is true.

Institutional Inve s t o r s : Organizations that professionally invest, including insurance companies, depository institutions, pension funds, investment companies, mutual funds, and endowment funds.

I n v estment Company Act of 1940: Investment Company Act shall mean the Investment Company Act of 1940, as amended, including the rules and regulations promulgated thereunder.

I n v estment Letter: A letter signed by an investor purchasing unregistered long securities under Regulation D, in which the investor attests to the long-term investment nature of the purchase. These securities must be held for a minimum of one year before they can be sold.

IRA Rollove r : The reinvestment of assets received as a lump-sum distribution from a qualified tax-deferred retirement plan. Reinvestment may be the entire lump sum or a portion thereof. If reinvestment is done within 60 days, there are no tax consequences.

I R R : Internal Rate of Return. A typical measure of how VC Funds measure performance. IRR is technically a discount rate: the rate at which the present value of a series of investments is equal to the present value of the returns on those investments.

Issued Share s : The amount of common shares that a corporation has sold (issued).

I s s u e r : Refers to the organization issuing or proposing to issue a security.

10.12 - K -

Kentucky Windage: In hunting, the modified aim required to compensate for wind or target movement. Used herein to describe the process by which an investor must increase the percentage he needs today so that he will end up with a desired target percentage ownership in the future, after adjusting for future dilutive financing rounds.

Key Employe e s : Professional management attracted by the founder to run the company. Key employees are typically retained with warrants and ownership of the company.

- L -

Later Stage: A stage of company growth characterized by viable products, a developed market, significant customers, sustained revenue growth, and both profits and positive cash flow from operations. Later-stage companies would generally be candidates for an IPO. Investments in the C round or after qualify as later stage.

Lead Investor: Also known as a bell cow investor. Member of a syndicate of private equity investors holding the largest stake, in charge of arranging the financing and most actively involved in the overall project.

L e ve r aged Buyout (LBO): A takeover of a company, using a combination of equity and borrowed funds. Generally, the target company’s assets act as the collateral for the loans taken out by the acquiring group. The acquiring gro u p then repays the loan from the cash flow of the acquired company. For example, a group of investors may borro w funds, using the assets of the company as collateral, in order to take over a company. Or the management of the company may use this vehicle as a means to regain control of the company by converting a company from public to private. In most LBOs, public shareholders receive a premium to the market price of the share s .

Limited Partner (LP): An investor in a limited partnership who has no voice in the management of the partnership. LPs have limited liability and usually have priority over GPs upon liquidation of the partnership.

Limited Pa r t n e r s h i p s : An organization comprised of a general partner, who manages a fund, and limited partners, who invest money but have limited liability and are not involved with the day-to-day management of the fund. In the typical venture capital fund, the general partner receives a management fee and a percentage of the profits (or carried interest). The limited partners receive income, capital gains, and tax benefits.

10.13 L i q u i d a t i o n : 1) The process of converting securities into cash. 2) The sale of the assets of a company to one or more acquirers in order to pay off debts. In the event that a corporation is liquidated, the claims of secured and unsecured creditors and owners of bonds and preferred stock take precedence over the claims of those who own common stock.

Liquidity Eve n t : An event that allows a VC to realize a gain or loss on an investment. The ending of a private equity p ro v i d e r’s involvement in a business venture with a view to realizing an internal re t u rn on investment. Most common exit routes include Initial Public Offerings [IPOs], buy backs, trade sales, and secondary buyouts. (See also: Exit St r a t e g y. )

Lock-up Pe r i o d : The period of time that certain stockholders have agreed to waive their right to sell their shares of a public company. Investment banks that underwrite initial public offerings generally insist upon lockups for a set period of time, typically 180 days from large shareholders (such as 1% ownership or more) in order to allow an orderly market to develop in the shares. The shareholders that are subject to lockup usually include the management and directors of the company, strategic partners, and such large investors. These shareholders have typically invested prior to the IPO at a significantly lower price to that offered to the public and therefore stand to gain considerable profits. If a shareholder attempts to sell shares that are subject to lockup during the lockup period, the transfer agent will not permit the sale to be completed.

- M -

Management Fe e : Compensation for the management of a venture fund’s activities, paid from the fund to the general partner or investment advisor. This compensation generally includes an annual management fee.

Management Team: The persons who oversee the activities of a venture capital fund.

M a r k et Capitalization: The total dollar value of all outstanding shares. Computed as shares multiplied by current price per share. Prior to an IPO, market capitalization is arrived at by estimating a company’s future growth and by comparing a company with similar public or private corporations. (See also: Pre-Money Valuation.)

M e r ger: Combination of two or more corporations in which greater efficiency is supposed to be achieved by the elimination of duplicate plant, equipment, and staff, and the reallocation of capital assets to increase sales and profits in the enlarged company.

10.14 Mezzanine Financing: Refers to the stage of venture financing for a company immediately prior to its IPO. Investors entering in this round have lower risk of loss than those investors who have invested in an earlier round. Mezzanine-level financing can take the structure of preferred stock, convertible bonds, or subordinated debt.

Mutual Fund: A mutual fund, or an open-end fund, sells as many shares as investor demand re q u i res. As money flows in, the fund grows. If money flows out of the fund, the number of the fund’s outstanding shares drops. Open- end funds are sometimes closed to new investors, but existing investors can still continue to invest money in the fund. In order to sell shares, an investor usually sells the shares back to the fund. If an investor wishes to buy additional s h a res in a mutual fund, the investor must buy newly issued shares directly from the fund. (See also: Closed-end Funds.)

- N -

N A S D : The National Association of Securities Dealers. A mandatory association of brokers and dealers in the over- the-counter securities business. Created by the Maloney Act of 1938, an amendment to the Securities Act of 1934.

N A S D AQ : An automated information network which provides brokers and dealers with price quotations on securities traded over the counter.

Net Asset Value (NAV ) : NAV is calculated by adding the value of all of the investments in the fund and dividing by the number of shares of the fund that are outstanding. NAV calculations are required for all mutual funds (or open-end funds) and closed-end funds. The price per share of a closed-end fund will trade at either a premium or a discount to the NAV of that fund, based on market demand. Closed-end funds generally trade at a discount to NAV.

Net Financing Cost: Also called the cost of carry or, simply, carry, the difference between the cost of financing the purchase of an asset and the asset’s cash yield. Positive carry means that the yield earned is greater than the financing cost; negative carry means that the financing cost exceeds the yield earned.

Net income: The net earnings of a corporation after deducting all costs of selling, depreciation, interest expense, and taxes.

Net Present Va l u e : An approach used in capital budgeting where the present value of cash inflow is subtracted from the present value of cash outflows. NPV compares the value of a dollar today versus the value of that same dollar in the future after taking inflation and return into account.

10.15 N e w Issue: A stock or bond offered to the public for the first time. New issues may be initial public offerings by previously private companies or additional stock or bond issues by companies already public. New public offerings are registered with the Securities and Exchange Commission. (See Securities and Exchange Commission and Registration.)

N e wc o : The typical label for any newly organized company, particularly in the context of a leveraged buyout.

No Shop, No Solicitation Clauses: A no shop, no solicitation, or exclusivity, clause requires the company to negotiate exclusively with the investor, and not solicit an investment proposal from anyone else for a set period of time after the term sheet is signed. The key provision is the length of time set for the exclusivity period.

N o n a c c r e d i t e d : An investor not considered accredited for a Regulation D offering. (See “Accredited Investor.”)

N Y S E : The New York Stock Exchange. Founded in 1792, the largest organized securities market in the United States. The Exchange itself does not buy, sell, own, or set prices of stocks traded there. The prices are determined by public supply and demand. Also known as the Big Board.

- O -

Offering Documents: Documents evidencing a private-placement transaction. Include some combination of a purchase agreement and/or subscription agreement, notes or stock certificates, warrants, registration-rights agreement, stockholder or investment agreement, investor questionnaire, and other documents required by the particular deal.

Open-end Fund: An open-end fund, or a mutual fund, generally sells as many shares as investor demand re q u i re s . As money flows in, the fund grows. If money flows out of the fund, the number of the fund’s outstanding share s d rops. Open-end funds are sometimes closed to new investors, but existing investors can still continue to invest money in the fund. In order to sell shares, an investor generally sells the shares back to the fund. If an investor wishes to buy additional shares in a mutual fund, the investor generally buys newly issued shares directly from the fund.

Option: A security granting the holder the right to purchase a specified number of a Company’s securities at a designated price at some point in the future. The term is generally used in connection with employee benefit plans as Incentive Stock Options (“ISOs” or “statutory options”) and Non-qualified stock options (“NSOs” or “Nonquals”). However “stand-alone options” may be issued outside of any plan. Generally non-transferable, in distinction to warr a n t s .

10.16 Option Pool: The number of shares set aside for future issuance to employees of a private company.

OTC: Over-the-Counter. A market for securities made up of dealers who may or may not be members of a formal securities exchange. The over-the-counter market is conducted over the telephone and is a negotiated market rather than an auction market such as the NYSE.

Outstanding Stock: The amount of common shares of a corporation which are in the hands of investors. It is equal to the amount of issued shares less treasury stock.

O v e r subscription: Occurs when demand for shares exceeds the supply or number of shares offered for sale. As a result, the underwriters or investment bankers must allocate the shares among investors. In private placements, this occurs when a deal is in great demand because of the company’s growth prospects.

O v e r subscription Privilege: In a rights issue, arrangement by which shareholders are given the right to apply for any shares that are not purchased.

- P -

Pari Pa s s u : At an equal rate or pace, without preference.

Participating Pre f e r r e d : A preferred stock in which the holder is entitled to the stated dividend and also to additional dividends on a specified basis upon payment of dividends to the common stockholders.

Participating Pre f e r r ed Stock: Preferred stock that has the right to share on a pro-rata basis with any distributions to the common stock upon liquidation, after already receiving the preferred-liquidation preference.

Pa r t n e r s h i p : A nontaxable entity in which each partner shares in the profits, losses, and liabilities of the partnership. Each partner is responsible for the taxes on its share of profits and losses.

Pa r t n e r ship Ag r e e m e n t : The contract that specifies the compensation and conditions governing the relationship between investors (LPs) and the venture capitalists (GPs) for the duration of a private equity fund’s life.

Pe n n y Stocks : Low-priced issues, often highly speculative, selling at less than $5/share.

10.17 Piggyback Registration: A situation when a securities underwriter allows existing holdings of shares in a corporation to be sold in combination with an offering of new public shares.

PIK Debt Securities: (Payment in Kind) PIK Debt are bonds that may pay bondholders compensation in a form other than cash.

P I P E : [“Private Investment for Public Equity”] Private offering followed by a resale registration.

P I V : Pooled Investment Vehicle. A legal entity that pools various investors’ capital and deploys it according to a specific investment strategy.

Placement Ag e n t : The investment bank, broker, or other person that locates investors to purchase securities from the Company in a private offering, in exchange for a commission.

Plain English Handbook: The Securities and Exchange Commission online version of “Plain English Handbook: How to Create Clear SEC Disclosure Documents.”

Poison Pill: A right issued by a corporation as a preventative to a takeover measure. It allows right holders to purchase shares in either their company or in the combined target and bidder entity at a substantial discount, usually 50%. This discount may make the takeover prohibitively expensive.

Po r t f olio Companies: Companies in which a given fund has invested.

Po s t - M o n e y Va l u a t i o n : The valuation of a company immediately after the most recent round of financing. This value is calculated by multiplying the company's total number of shares by the share price of the latest financing.

P r e - M o n e y Va l u a t i o n : The valuation of a company prior to a round of investment. This amount is determined by using various calculation models, such as discounted P/E ratios multiplied by periodic earnings or a multiple times a future cash flow discounted to a present cash value and a comparative analysis to comparable public and private companies.

P r e e m p t i v e Right: A shareholder's right to acquire an amount of shares in a future offering at current prices per share paid by new investors, whereby his/her percentage ownership remains the same as before the offering.

P r e f e r r ed Dividend: A dividend ordinarily accruing on preferred shares payable where declared and superior in right of payment to common dividends.

10.18 P r e f e r r ed Stock: A class of capital stock that may pay dividends at a specified rate and that has priority over common stock in the payment of dividends and the liquidation of assets. Many venture capital investments use p re f e rred stock as their investment vehicle. This pre f e rred stock is convertible into common stock at the time of an IPO.

P r i v ate Equity: Equity securities of companies that have not “gone public” (are not listed on a public exchange). Private equities are generally illiquid and thought of as a long-term investment. As they are not listed on an exchange, any investor wishing to sell securities in private companies must find a buyer in the absence of a marketplace. In addition, there are many transfer restrictions on private securities. Investors in private securities generally receive their re t u rn through one of three ways: an initial public offering, a sale or merg e r, or a re c a p i t a l i z a t i o n .

P r i v ate Offering/Private Placement: Sale of unregistered, restricted securities by the company.

P r i v ate Placement: Also known as a Reg. D offering. The sale of a security directly to a limited number of investors in a private transaction.

P r i v ate Placement Memora n d u m : Also known as an Offering Memorandum. A document that outlines the terms of securities to be offered in a private placement. Resembles a business plan in content and structure.

P r i v ate Securities: Private securities are securities that are not registered and do not trade on an exchange. The price per share is set through negotiation between the buyer and the seller or issuer.

P r omissory Note: [“Note”] Debt instrument in which the maker promises to pay the holder according to its terms.

P r o s p e c t u s : A formal written offer to sell securities that provides an investor with the necessary information to make an informed decision. A prospectus explains a proposed or existing business enterprise and must disclose any material risks and information according to the securities laws. A prospectus must be filed with the SEC and be given to all potential investors. Companies offering securities, mutual funds, and offerings of other investment companies including Business Development Companies are required to issue prospectuses describing their history, investment philosophy or objectives, risk factors, and financial statements. Investors should carefully read them prior to investing.

10.19 Public Company : A company that has securities that have been sold in a re g i s t e red offering and that are traded on a stock exchange or NASDAQ. Must be a Reporting Company under SEC rules. Often used incorrectly to describe companies that are only Reporting Companies and that have not conducted a re g i s t e red offering under Securities Act.

Put option: The right to sell a security at a given price (or range) within a given time period.

- Q -

Q PA M : Qualified professional asset manager as defined by ERISA.

- R -

R e c a p i t a l i z a t i o n : The reorganization of a company’s capital structure. A company may seek to save on taxes by replacing preferred stock with bonds in order to gain interest deductibility. Recapitalization can be an alternative exit strategy for venture capitalists and leveraged-buyout sponsors. (See also: Exit Strategy and Leveraged Buyout.)

R e c o n f i r m a t i o n : The act a broker/dealer makes with an investor to confirm a transaction.

Red Herring: The common name for a preliminary prospectus, due to the red SEC required legend on the cover. (See also: Prospectus.)

Redeemable Pre f e r r ed Stock: Redeemable preferred stock, also known as exploding preferred, at the holder’s option after (typically) five years, which in turn gives the holders (potentially converting to creditors) leverage to induce the company to arrange a liquidity event. The threat of creditor status can move the founders off the dime if a liquidity event is not occurring with sufficient rapidity.

R e g i s t e r ed Offering: [“Public Offering”] A transaction in which a Company sells specified securities to the public under a Registration Statement which has been declared effective by the SEC.

R e g i s t r a t i o n : The SEC’s review process of all securities intended to be sold to the public. The SEC requires that a registration statement be filed in conjunction with any public securities offering. This document includes operational and financial information about the company, the management, and the purpose of the offering. The registration statement and the prospectus are often referred to interchangeably. Technically, the SEC does not “approve” the disclosures in prospectuses.

10.20 R e g i s t r ation Obligation: The obligation of Company to register the shares issued to an investor in a private offering for resale to the public through a Registration Statement which the SEC has declared effective.

R e g i s t r ation Rights: The right to require that a company register restricted shares. Demand Registered Rights enable the shareholder to request registration at any time, while Piggy Back Registration Rights enable the shareholder to request that the company register his or her shares when the company files a registration statement (for a public offering with the SEC).

R e g i s t r ation Rights Ag r eement: Separate agreement in which the investor’s registration rights are evidenced.

R e g i s t r ation Statement: The document filed by a Company with the SEC under the Securities Act in order to obtain approval to sell the securities described in the Registration Statement to the public. [S-1, S-2, S-3, S-4, SB-1, SB-2, S-8, etc.] Includes the Prospectus.

Regulation A: SEC provision for simplified registration for small issues of securities. A Reg. A issue may require a shorter prospectus and carries lesser liability for directors and officers for misleading statements.

Regulation C: The regulation that outlines registration requirements for Securities Act of 1933.

Regulation D: Regulation D is the rule (Reg. D is a “regulation” comprising a series of “rules”) that allow for the issuance and sale of securities.

Regulation D Offering: (See Private Placement.)

Regulation S: The rules relating to Offers and Sales made outside the US without SEC Registration.

Regulation S-B: Reg. S-B of the Securities Act of 1933 governs the Integrated Disclosure System for Small Business Issuers.

Regulation S-K: The Standard Instructions for Filing Forms Under Securities Act of 1933, Securities Exchange Act of 1934, and Energy Policy and Conservation Act of 1975.

Regulation S-X: The regulation that governs the requirements for financial statements under the Securities Act of 1933 and the Securities Exchange Act of 1934.

10.21 Reporting Company : A company that is registered with the SEC under the Exchange Act.

Resale Registra t i o n : Registration by a Company of the investor’s sale of the shares purchased by the investor in a private offering.

Restricted Securities: Public securities that are not freely tradable due to SEC regulations. (See also: Securities and Exchange Commission.)

Restricted Share s : Shares acquired in a private placement are considered restricted shares and may not be sold in a public offering absent registration or after an appropriate holding period has expired. Non-affiliates must wait one year after purchasing the shares, after which time they may sell less than 1% of their outstanding shares each quarter. For affiliates, there is a two-year holding period.

Right of First Refusal: The right of first refusal gives the holder the right to meet any other offer before the proposed contract is accepted.

Rights Offering: Issuance of “rights” to current shareholders allowing them to purchase additional shares, usually at a discount to market price. Shareholders who do not exercise these rights are usually diluted by the offering. Rights are often transferable, allowing the holder to sell them on the open market to others who may wish to exercise them. Rights offerings are particularly common to closed-end funds, which cannot otherwise issue additional ordinary shares.

R i s k : The chance of loss on an investment due to many factors, including inflation, interest rates, default, politics, foreign exchange, call provisions, etc. In Private Equity, risks are outlined in the Risk Factors section of the Placement Memorandum.

Rule 144: Rule 144 provides for the sale of restricted stock and control stock. Filing with the SEC is required prior to selling restricted and control stock, and the number of shares that may be sold is limited.

10.22 Rule 144A: A safe-harbor exemption from the registration requirements of Section 5 of the 1933 Act for resales of certain restricted securities to qualified institutional buyers, which are commonly referred to as “QIBs.” In particular, Rule 144A affords safe-harbor treatment for reoffers or resales to QIBs — by persons other than issuers — of securities of domestic and foreign issuers that are not listed on a U.S. securities exchange or quoted on a U.S. automated inter-dealer quotation system. Rule 144A provides that reoffers and resales in compliance with the rule are not “distributions” and that the reseller is therefore not an “underwriter” within the meaning of Section 2(a)(11) of the 1933 Act. If the reseller is not the issuer or a dealer, it can rely on the exemption provided by Section 4(1) of the 1933 Act. If the reseller is a dealer, it can rely on the exemption provided by Section 4(3) of the 1933 Act.

Rule 144A Exchange Offer: A transaction in which one class of securities that were issued in a private placement are exchanged for another, unusually almost identical, class of securities, in a transaction registered with the SEC on a Form S-4 Registration Statement.

Rule 501: Rule 501 of Regulation D defines Accredited Investor, among other definitions and regulations.

Rule 505: Rule 505 of Regulation D is an exemption for limited offers and sales of securities.

Rule 506: Rule 506 of Regulation D is considered a “safe harbor” for the private-offering exemption of Section 4(2) of the Securities Act of 1933. Companies using the Rule 506 exemption can raise an unlimited amount of money if they meet certain exemptions.

- S -

SBIR: Small Business Innovation Research Program. See Small Business Innovation Development Act of 1982.

Secondary Sale: The sale of private or restricted holdings in a portfolio company to other investors.

Securities: Includes all types of equity and debt instruments and rights in and to them.

Securities Act of 1933: The federal law covering new issues of securities. It provides for full disclosure of pertinent information relating to the new issue and also contains antifraud provisions.

Securities Act of 1934: The federal law that established the Securities and Exchange Commission. The act outlaws misrepresentation, manipulation, and other abusive practices in the issuance of securities.

10.23 Securities and Exchange Commission: The SEC is an independent, nonpartisan, quasi-judicial re g u l a t o r y agency that is responsible for administering the federal securities laws. These laws protect investors in securities markets and e n s u re that investors have access to all material information concerning publicly traded securities. Additionally, the SEC regulates firms that trade securities, people who provide investment advice, and investment companies.

Seed Money : The first round of capital for a start-up business. Seed money usually takes the structure of a loan or an investment in preferred stock or convertible bonds, although sometimes it is common stock. Seed money provides startup companies with the capital required for their initial development and growth. Angel investors and early-stage venture capital funds often provide seed money.

Seed Stage Financing: An initial state of a company’s growth characterized by a founding management team, business-plan development, prototype development, and beta testing.

Senior Securities: Securities that have a preferential claim over common stock on a company’s earnings and in the case of liquidation. Generally, preferred stock and bonds are considered senior securities.

Series A Pre f e r r ed Stock: The first round of stock off e red during the seed or early-stage round by a port f o l i o company to the venture investor or fund. This stock is convertible into common stock in certain cases such as an IPO or the sale of the company. Later rounds of pre f e rred stock in a private company are called Series B, Series C, and so on.

Shell Corporation: A corporation with no assets and no business. Typically, shell corporations are designed for the purpose of going public and later acquiring existing businesses. Also known as Specified Purpose Acquisition Companies (SPACs).

Small Business Ad m i n i s t r ation (SBA ) : Provides loans to small-business investment companies (SBICs) that supply venture capital and financing to small businesses.

Small Business Innovation Development Act of 1982: The Small Business Innovation Research (SBIR) program is a set-aside program for domestic small-business concerns to engage in Research/Research and Development (R/R&D) that has the potential for commercialization. The SBIR program was established under the Small Business Innovation Development Act of 1982, reauthorized until September 30, 2000 by the Small Business Research and Development Enhancement Act, and reauthorized again until September 30, 2008 by the Small Business Reauthorization Act of 2000.

10.24 S t a g g e r ed Board : This is an anti-takeover measure in which the election of the directors is split in separate periods so that only a percentage (e.g., one-third) of the total number of directors come up for election in a given year. It is designed to make taking control of the board of directors more difficult.

Statutory Vo t i n g : A method of voting for members of the Board of Directors of a corporation. Under this method, a shareholder receives one vote for each share and may cast those votes for each of the directorships. For example: An individual owning 100 shares of stock of a corporation that is electing six directors could cast 100 votes for each of the six candidates. This method tends to favor the larger shareholders.

Stock Options: 1) The right to purchase or sell a stock at a specified price within a stated period. Options are a popular investment medium, offering an opportunity to hedge positions in other securities, to speculate on stocks with relatively little investment, and to capitalize on changes in the market value of options contracts themselves through a variety of options strategies. 2) A widely used form of employee incentive and compensation. The employee is given an option to purchase its shares at a certain price (at or below the market price at the time the option is granted) for a specified period of years.

S t r ategic Inve s t o r s : Corporate or individual investors that add value to investments they make through industry and personal ties that can assist companies in raising additional capital as well as provide assistance in the marketing and sales process.

Subscription Ag r e e m e n t : The application submitted by an investor wishing to join a limited partnership. All prospective investors must be approved by the General Partner prior to admission as a partner.

S u b o r dinated [Note] [Debt]: Debt which by its terms has no right to be paid until another debt holder is paid. Also referred to as “junior” debt.

S y n d i c a t e : Underwriters or broker/dealers who sell a security as a group.

10.25 - T -

Tag-Along Rights / Rights of Co-Sale: A minority-shareholder protection affording the right to include their shares in any sale of control and at the offered price.

Ta ke d o wn Schedule: A takedown schedule means the timing and size of the capital contributions from the limited partners of a venture fund.

Ta x - f r ee re o r g a n i z a t i o n s : Types of business combinations in which shareholders do not incur tax liabilities. There are four types — A, B, C, and D re o rganizations. They differ in various ways in the amount of stock/cash that can be off e red.

Tender offer: An offer to purchase stock made directly to the shareholders. One of the more common ways hostile takeovers are implemented.

Term Sheet: A summary of the terms the investor is prepared to accept. A non-binding outline of the principal points which the Stock Purchase Agreement and related agreements will cover in detail.

Time Value of Money : The basic principle that money can earn interest; therefore, something that is worth $1 today will be worth more in the future if invested. This is also referred to as future value.

Treasury Stock: Stock issued by a company but later reacquired. It may be held in the company’s treasury indefinitely, reissued to the public, or retired. Treasury stock receives no dividends and does not carry voting power while held by the company.

Trust Indenture: Agreement between the Company, the debt holders, and the trustee for the debt holders. Required for registered offerings of debt securities. (See Trust Indenture Act of 1939.)

10.26 - U -

U L PA : Uniform Limited Partnership Act, see also the RULPA, Revised Uniform Limited Partnership Act U.L.P.A. § 101 et seq. (1976), as amended in 1985 (R.U.L.P.A.).

U n d e r w r i t e r : In jargon, the “underwriters” are the investment banks selling the securities in an underwritten registered offering. But beware, under the Securities Act, the class of persons who are considered “underwriters” is far more expansive and problematic.

Underwritten Offering: Registered offering that is sold through a consortium of investment banks assembled by one or more lead investment banks.

Unit Offering: Private or public offering of securities in groups of more than one security. Most often a share of stock and warrant to purchase some number of shares of stock, but could be two shares of stock, a note and a share of stock, etc. Also used in some cases to refer to the sale of LP and LLC interests, since those interests are composed of more than one right.

- V -

Ve n t u r e Capital Financing: An investment in a startup business that is perceived to have excellent growth prospects but does not have access to capital markets. Type of financing sought by early-stage companies seeking to grow rapidly.

Voting Right: The common stockholders’ right to vote their stock in the affairs of the company. Preferred stock usually has the right to vote when preferred dividends are in default for a specified amount of time. The right to vote may be delegated by the stockholder to another person.

10.27 - W -

Wa r ra n t : A type of security that entitles the holder to buy a proportionate amount of common stock or preferred stock at a specified price for a period of years. Warrants are usually issued together with a loan, a bond, or preferred stock and act as sweeteners, to enhance the marketability of the accompanying securities. They are also known as stock-purchase warrants and subscription warrants.

Weighted Ave r age Antidilution: The investor’s conversion price is reduced, and thus the number of common shares received on conversion increased, in the case of a down round; it takes into account both: (a) the reduced price and, (b) how many shares (or rights) are issued in the dilutive financing.

Williams Act of 1968: An amendment of the Securities and Exchange Act of 1934 that regulates tender offers and other takeover-related actions such as larger share purchases.

Wo r ko u t : A negotiated agreement between the debtor and its creditors outside the bankruptcy process.

Wr i t e - o ff: The act of changing the value of an asset to an expense or a loss. A write-off is used to reduce or eliminate the value of an asset and reduce profits.

Wr i t e - u p / W r i t e - d o w n : An upward or downward adjustment of the value of an asset for accounting and reporting purposes. These adjustments are estimates and tend to be subjective, although they are usually based on events affecting the investee company or its securities beneficially or detrimentally.

10.28 A P P E N D I X 1 1 I N V E S T O R - V S . C O M P A N Y - F A V O R A B L E T E R M S H E E T ( S A M P L E 1 )

[Notes: Where appropriate, investor-favorable provisions in this Te rm Sheet are denoted “IF” and company- favorable provisions are denoted “CF.” Where certain provisions in this Te rm Sheet call for a number, we have included a range, the endpoints of which re p resent investor-favorable or company-favorable term s , depending on the circ u m s t a n c e s . ]

This Term Sheet dated ______, 200_ _ _ _ outlines the terms and conditions of a proposed investment by [Investor Name]. (“Investor”) and the other investors listed on Exhibit A hereto (together with Investor, the “Investors”) in [Company Name], a [State] corporation (the “Company”). This Term Sheet is an expression of intent only, and is not to be construed as a binding agreement, except for the “Exclusivity” and “Confidentiality” provisions contained herein.

OFFERING TE RMS

Issuer: [Company Name], a [State] corporation.

Amount of Financing: A minimum of $______and up to a maximum of $______, [including $______received pursuant to outstanding bridge notes (the “Bridge Notes’).

Type of Security: Series A Preferred Stock (the “Series A Preferred”), initially convertible on a 1:1 basis into shares of the Company’s Common Stock (the “Common Stock”).

Price: $______per share (the “Original Purchase Price”). The Original Purchase Price represents a fully diluted pre- money valuation of $______million.

Investors: Investor $______shares

The other Investors listed on Exhibit A hereto $______shares

[The Bridge Notes listed on Exhibit B hereto*] $______shares

[* At the Closing, the outstanding principal of the Bridge Notes will automatically convert into shares of Series A Preferred at a conversion price equal to [75-100%] of the Original Purchase Price. All accrued interest, if any, will be paid at the Closing by the Company.]

11.1 Anticipated Closing Date: On or before ______, 200_ _ _ _ (the “Closing”) [, with a subsequent closing to occur on or before [15-60] days following the Closing].

Post-Closing Capitalization: As set forth in the table attached as Exhibit [B] hereto. [IF: The authorized but unissued shares of the Company as of the Closing shall not exceed by more than 5% the capitalization set forth on Exhibit [B]].

Use of Proceeds: Proceeds from the investment will be used for [working capital and general corporate purposes] and ______. [IF: All other outstanding stockholder debt and deferred compensation will be converted into equity and reflected on the Company’s capitalization table, and hence considered paid-in capital, prior to the Closing.]

TE RMS OF SE RIES A PREFERRED

Dividends: The holders of the Series A Preferred shall be entitled to receive [IF: cumulative] [CF: noncumulative] dividends in preference to any dividend on the Common Stock at the rate of 8% of the Original Purchase Price per annum [CF: when and as declared by the Board of Directors.] The holders of the Series A Preferred also shall be entitled to participate pro rata in any dividends paid on the Common Stock on an as-converted-to-Common Stock basis.

Liquidation Pre f e r e n c e : In the event of any liquidation or winding up of the Company, the holders of the Series A Pre f e rred shall be entitled to receive in pre f e rence to the holders of the Common Stock a per- s h a re amount equal to [I F : ______times] the Original P u rchase Price (as adjusted for any stock splits, dividends, and the like) plus any declared but unpaid dividends [I F : and accrued interest thereon at a rate of [8%-10%] per annum] (the “Liquidation Pre f e re n c e ”). [I F : After the payment of the Liquidation Preference to the holders of the Series A Preferred, the remaining assets of the Company shall be distributed ratably to the holders of the Common Stock and the Series A Preferred on an as-converted-to-Common- Stock basis.] [I F : After the payment of the Liquidation Preference to the holders of the Series A Preferred, the remaining assets of the Company shall be distributed ratably to the holders of the Common Stock and the Series A Preferred on an as-converted-to-Common-Stock basis until the holders of Series A Preferred have received an additional [two-four] times the Original Purchase Price per share; thereafter, the remaining assets of the Company shall be distributed to the holders of Common Stock.] [C F : After the payment of the Liquidation Pre f e rence to the holders of the Series A Pre f e rred, the remaining assets of the Company shall be distributed ratably to the holders of the Common Stock until the holders of Common Stock shall have received a per- s h a re amount equal to $______p e r s h a re (as adjusted for any stock splits, dividends, and the like); there a f t e r, the remaining assets of the Company shall be distributed ratably to the holders of the Common Stock and the Series A Pre f e rred on an as-c o n v e rt e d - t o - C o m m o n - S t o c k

11.2 b a s i s . ] [C F : After the payment of the Liquidation Pre f e rence to the holders of the Series A Pre f e rre d, the re m a i n i n g assets of the Company shall be distributed ratably to the holders of the Common Stock.] A merg e r, acquisition, or sale of voting control in which the stockholders of the Company immediately prior to the transaction do not own a majority of the outstanding shares of the surviving corporation or sale or lease of substantially all of the assets of the Company [I F : o r license of substantially all of the intellectual pro p e rty of the Company] shall be deemed to be a liquidation.

Conversion: The holders of the Series A Preferred shall have the right to convert the Series A Preferred, at the option of the holder, at any time, into shares of Common Stock. The initial conversion rate shall be one share of Series A Preferred into one share of Common Stock, subject to adjustment as provided below.

Automatic Conversion: The Series A Preferred shall be automatically converted into Common Stock, at the then-applicable conversion price, (i) in the event that the holders of at least [IF: 66 2/3%] [CF: a majority] of the outstanding Series A Preferred consent to such conversion or (ii) upon the closing of a firmly underwritten public offering of shares of Common Stock at a per-share price not less than [3-5] times the Original Purchase Price (as adjusted for stock splits, dividends and the like) per share and for a total offering of not less than [$15-35] million ([IF: after] [CF: before] deduction of underwriters’ commissions and expenses) (a “Qualified IPO”).

Antidilution Provisions: The conversion price of the Series A Pre f e rred will be subject to a [I F : full ratchet] [I F : narrow-based weighted average] [C F : broad-based weighted average] adjustment to reduce dilution in the event that the Company issues additional equity securities at a purchase price less than the applicable conversion price. The conversion price of the Series A Pre f e rred will not be adjusted for the following issuances: (i) s h a res of Common Stock issued upon conversion of or as a dividend or distribution on the Series A Pre f e r red, (ii) [I F : no more than ______shares of restricted stock or stock options granted to officers, directors, employees, or consultants as approved by the Company’s Board of Directors [I F : including the Series A Director(s) (as defined below)], (iii) shares of Common Stock subject to outstanding options, warrants or convertible securities as of the date hereof, (iv) the issuance of Common Stock or rights to purchase Common Stock issued in connection with equipment lease financing arrangements, credit agreements, debt financings, or other commercial transactions approved by the Board of Directors [I F : including the Series A Director(s)], (v) shares of Common Stock or rights to purchase Common Stock issued for consideration other than cash pursuant to a merger, consolidation, acquisition or similar business combination approved by the Board of Directors [I F : including the Series A Director(s)]. [The Series A Preferred will contain a “pay-to-play” feature whereby in the event of a dilutive issuance after the Closing, each Investor must purchase its full pro-rata share of such issuance in order to maintain its antidilution protection.] The conversion price will also be subject to pro p o rt i o n a l adjustment for stock splits, stock dividends, recapitalizations, and the like.

11.3 Redemption at Option: of Investors: At the election of the holders of at least [I F : a majority] [C F : 66 2/3%] of the Series A Pre f e rred, the Company shall redeem the outstanding Series A Pre f e r red [I F : on or after ______, 200___ ] [C F : in [three-seven] annual installments beginning on the [third-seventh] anniversary of the Closing]. Such redemptions shall be at a purc h a s e price equal to one hundred percent of the Original Purchase Price [I F : plus declared and unpaid dividends]. [I F : To the extent that the Company’s available cash flow does not permit such redemption, the remainder shall be paid in the form of a one-year promissory note to each unredeemed holder of Series A Preferred bearing interest at a rate of [8-10%] per annum, and the holders of a majority of Series A Preferred shall be entitled to elect a majority of the Company’s Board of Directors until all principal and interest owing under such notes is paid in full.]

Voting Rights: The Series A Preferred will vote together with the Common Stock and not as a separate class except as specifically provided herein or as otherwise required by law. Each share of Series A Preferred shall have a number of votes equal to the number of shares of Common Stock then issuable upon conversion of such share of Series A Preferred.

Board of Directors: The size of the Company’s Board of Directors shall be set at [three-five]. At the Closing, the Board shall initially be comprised of [______], [with the Mutual Director (as defined below) to be appointed after the Closing].

At each subsequent meeting for the election of directors, the holders of the Series A Preferred, voting as a separate class, shall be entitled to elect [one-two] members of the Company’s Board of Directors (the “Series A Directors”), the holders of the Common Stock, voting as a separate class, shall be entitled to elect [two-three] members of the Company’s Board of Directors, and the remaining director will be selected by a majority vote of the holders of the Series A Preferred and the Common Stock, voting together as a single class (the “Mutual Director”).

The Company will indemnify board members to the maximum extent permitted by applicable law. [IF: The Company will carry directors & officers insurance with coverage as approved by the Company’s Board of Directors.]

The Board of Directors’ meetings shall be held [monthly] [quarterly] until such time as the Board unanimously determines that [monthly] [quarterly] meetings are not required. The Company will reimburse directors for their customary and reasonable expenses in attending Board meetings.

[IF: The Board of Directors will establish a Compensation Committee, if none exists, to recommend management compensation, the Company benefit plans, and general equity-incentive plans for approval by the Board. The Compensation Committee shall contain no more than three persons, at least one of whom shall be a Series A Director. All decisions regarding executive compensation and the Company’s equity-incentive plans shall be made only by the Compensation Committee, acting unanimously.] 11.4 Protective Provisions: The Company may not, without the consent of holders of at least [I F : 66 2/3%] [C F : a majority] of the Series A P re f e rred: (i) d e c l a re or pay any dividends or make any distributions upon any of its equity securities; (ii) p u rc h a s e , redeem, or otherwise acquire any of the Company’s equity securities (including warrants, options, and other rights to a c q u i re equity securities) other than the re p u rchase of equity securities pursuant to existing agreements; (iii) l i q u i d a t e or dissolve; (iv) m e rge or consolidate with another corporation in which the holders of the Company’s voting equity securities immediately prior to the transactions own 50% or less of the voting securities of the surviving corporation; ( v ) sell, license, or dispose of all or substantially all of the Company’s assets, technology or intellectual pro p e rt y ; ( v i ) change the authorized number of directors; (vii) c reate any new class or series of shares having rights, pre f e re n c e s or privileges [I F : on a parity with or] senior to the Series A Pre f e rred; (viii) amend or waive any provision of its C e rtificate of Incorporation or Bylaws [C F : in a manner that alters or changes the voting or other powers, preferences, or other special rights or privileges of the Series A Preferred [so as to affect them adversely]]; ( i x ) i n c rease or decrease the authorized number of shares of Series A Pre f e rred; (x) increase or decrease the authorized number of shares of Pre f e rred Stock; (xi) i n c rease or decrease the authorized number of shares of Common Stock; [I F : (x) change the nature of its business; or (xi) authorize or incur any indebtedness in excess of $______].

Information Rights: [C F : Upon the request of such Investor,] the Company shall deliver to each Investor [C F : holding more than ______shares of Registrable Securities] audited annual financial statements no later than 120 days following the close of the fiscal year and unaudited quarterly financial statements no later than 45 days following the close of such period. [C F : Upon the request of such Investor,] the Company will also furnish such Investor with monthly financial statements no later than 30 days following the close of such period and will provide a copy of the Company’s annual operating plan no later than 30 days prior to the beginning of the fiscal year. Such Investor shall also be entitled to standard inspection and visitation rights. These provisions shall terminate upon a [I F : Qualified IPO] [C F : IPO] [C F : acquisition, merger, or consolidation of the Company.]

11.5 Registration Rights: Demand Rights. If Investors holding more than [25-50%] of the outstanding shares of Series A Preferred, including Common Stock issued on conversion of Series A Preferred (collectively, “Registrable Securities”), request that the Company file a registration statement having an aggregate offering price to the public of not less than ($5,000,000-$10,000,000], the Company will use its [CF: reasonable] best efforts to cause such shares to be registered, provided, however, that the Company shall not be obligated to effect any such registration prior to the [second-fifth] anniversary of the Closing. [CF: The Company shall have the right to delay such registration under certain circumstances for one period not in excess of 90 days in any 12-month period.]

The Company shall not be obligated to effect more than [one-two] registrations under these demand-right pro v i s i o n s , and shall not be obligated to effect a registration (i) during the [120-180] day period commencing with the date of the C o m p a n y ’s initial public offering, or (ii) if it delivers notice to the holders of the Registrable Securities within 30 days of any registration request of its intent to file a registration statement for such initial public offering within 90 days.

“Piggyback” Rights. The Investors shall be entitled to “piggyback” registration rights on all registrations of the Company or on any demand registrations of any other investor subject to the right, however, of the Company and its underwriters to reduce the number of shares proposed to be registered pro rata in view of market conditions. [IF: If the Investors are so limited, however, no party shall sell shares in such registration other than the Company or the Investor, if any, invoking a demand registration.] [IF: Unless the registration is with respect to the Company’s initial public offering, in which shares are sold only for the account of the Company, in no event shall the shares to be sold by the Investors be reduced below [20-40%] of the total amount of securities included in the registration.] No stockholder of the Company shall be granted piggyback registration rights which would reduce the number of shares includable by the holders of the Registrable Securities in such registration without the consent of the holders of at least [IF: 66 2/3%] [CF: a majority] of the Registrable Securities.

S-3 Rights. [CF: Upon initiation by Investors holding at least (10-30%] of the outstanding shares of Series A Preferred,] Investors shall be entitled to [IF: unlimited] demand registrations on Form S-3 (if available to the Company), so long as such registered offerings are not less than [$500,000-$1,000,000]. [CF: The Company shall be obligated to effect no more than [two-four] S-3 registrations in any 12-month period.]

Expenses. The Company shall bear registration expenses (exclusive of underwriting discounts and commissions) of all such demands, piggy-backs and [CF: up to [two-four] S-3 registrations (including fees and expenses [CF: up to [$10,000-$25,000]] of one special counsel for the selling stockholders).

11.6 Te rmination of Registration Rights. The demand, piggyback, and S-3 registration rights shall terminate upon the earlier to occur of (i) [ t h re e-seven] years following the Company’s [I F : Qualified IPO] [C F : IPO] or (ii) as to any Investor, at such time as such Investor could sell all of its Series A Pre f e rred during any three-month period under Rule 144.

Subsequent Registration Rights. Following the Closing, the Company shall not grant any registration rights senior to [IF: or pari passu with] those of the Investors without the consent of the holders of [IF: 66 2/3%] [CF: a majority] of the Registrable Securities.

Lock-Up Provision. Each Investor agrees that it will not sell its shares for a specified period (not to exceed [120-180] days) following the effective date of the Company’s IPO, provided that all officers, directors, and other [1-5%] stockholders are similarly bound.

Other Provisions. Other provisions shall be contained in the Investor Rights Agreement with respect to registration rights as are reasonable, including cross-indemnification, the period of time in which the Registration Statement shall be kept effective, and underwriting arrangements.

Right of First Refusal: In the event the Company proposes to offer equity securities to any person, each Investor [CF: holding more than ______shares of Registrable Securities] shall have the right, based on its percentage equity ownership of [IF: Series A Preferred] [CF: Common Stock, measured on a fully-diluted basis] to purchase its pro rata portion of such shares, provided that such right shall terminate upon a [IF: Qualified IPO] [CF: IPO] [CF: acquisition, merger, or consolidation of the Company] and shall not apply to (i) shares of Common Stock issued upon conversion of or as a dividend or distribution on the Series A Preferred, (ii) no more than ______shares of restricted stock or stock options granted to officers, directors, employees, advisors, or consultants as approved by the Company’s Board of Directors [IF: including the Series A Director(s)], (iii) shares of Common Stock subject to outstanding options, warrants, or convertible securities as of the date hereof (iv) shares of Common Stock or rights to purchase Common Stock issued in connection with equipment lease financing arrangements, credit agreements, debt financings, or other commercial transactions unanimously approved by the Board of Directors [IF: including the Series A Director(s)], or (v) shares of Common Stock or rights to purchase Common Stock issued for consideration other than cash pursuant to a merger, consolidation, acquisition, or similar business combination approved by the Board of Directors [IF: including the Series A Director(s)]. [IF: Any securities not subscribed for by an Investor may be reallocated among the other Investors.]

11.7 [IPO Participation Rights:] [IF: To the extent permitted by applicable law and SEC policy, the Investors shall have the right to purchase up to [5-15%] of the shares offered in the Company’s IPO. To the extent such right is limited by applicable law or SEC policy, the Investors shall instead have the right to buy that number of shares equal to [5-15%] of the shares offered in the Company’s IPO in a concurrent private placement.]

Purchase Agreement: The investment shall be made pursuant to a Stock Purchase Agreement reasonably acceptable to the Company and the Investors, which agreement shall contain, among other things, appropriate representations and warranties of the Company [IF: and of the Founders (as defined below)], covenants of the Company reflecting the provisions set forth herein and appropriate conditions of closing, including satisfactory completion of financial and legal due diligence and an opinion of counsel for the Company.

Qualified Small Business Stock: The Company shall make re p resentations satisfactory to the Investors that the Series A Pre f e rred is “qualified small business stock” within the meaning of Section 1202 of the Internal Revenue Code of 1986, as amended. Additionally, the Company shall not perf o rm any act that would alter this “qualified small business stock” designation without the consent of a majority of the Board of Directors.

Management Rights Letter: The Company shall execute a Management Rights Letter with each Investor in form and substance acceptable to such Investor.

E M P L O YEE MAT T E R S

Employee Pool: The Company will reserve ______shares of its Common Stock ([15-30%] of its fully diluted capital stock following the issuance of its Series A Preferred) for issuances to directors, officers, employees, and consultants, as set forth on Exhibit [B] hereto.

Founder Vesting: As of the Closing, the Common Stock held by the Founders (“Founder Common Stock”) shall vest as follows: [C F : [25-50%] will vest as of the Closing, with [50-75%] to vest [monthly] [quarterly] over the next [two-four] years. The Company shall have the option to re p u rchase all unvested Founder Common Stock at cost. [C F : Upon a termination without Cause (which shall include, but not be limited to, failure to perform duties to the satisfaction of the Board of Directors, malfeasance, death, disability, and other acts or omissions commonly included in the definition of Cause) an additional 12 months of the Founder Common Stock shall vest, provided that the same 12 months of otherwise vested Founder Common Stock shall be subject to repurchase by the Company in the event that the Founder voluntarily terminates his employment with the Company.]

11.8 Non-Founder Vesting: Except as otherwise approved by the Investors, all Common Stock, options, and other stock equivalents issued to employees, directors, consultants, and other service providers will be subject to vesting as follows: [25-50%] to vest on the first anniversary of such issuance, with the remaining [50-75%] to vest [monthly] [quarterly] over the next three years. The Company shall have the option to repurchase all unvested shares at cost.

Restrictions on Transfer: [I F : No transfers of unvested Common Stock shall be permitted.] No transfers of Common Stock shall be perm i t t e d for a specified period (not to exceed (120-180] days) following the effective date of the Company’s IPO. The Company’s Bylaws shall contain a right of first refusal on all transfers of Common Stock, subject to customary exceptions. If the Company elects not to exercise such right, the Company shall assign such right to the Investors on a pro-rata basis [I F : (with any shares not subscribed for by an Investor subject to reallocation among the other Investors)].

Proprietary Information: and Inventions Agreements: Prior to the Closing, the Company will enter into Proprietary Information and Inventions Agreements [IF: in form and substance acceptable to the Investors] with all officers, employees, and consultants, containing standard provisions with respect to confidentiality, corporate ownership of inventions and innovations, and noncompetition and nonsolicitation of employees and customers.

Right of Refusal and: Co-Sale Agreement: The shares of Common Stock held by ______(the “ F o u n d e r s ”) shall be subject to restrictions on transfer and made subject to a right of first refusal and co-sale agreement (with the exceptions set fort h below) with the Investors such that the Founders may not sell, transfer, or exchange their stock unless the Company first, and each of the Investors, second, has an opportunity to purchase such shares, which purchase with respect to the Investors shall be on a pro-rata basis [I F : (provided that any shares not subscribed for by an Investor may be reallocated among the other Investors)] and if such rights are not fully exercised, then each Investor has an opport u n i t y to participate in the sale by a Founder to a third party on a pro-rata basis. These rights of first refusal and co-sale shall not apply to and shall terminate upon a [I F : Qualified IPO] [C F : IPO] [C F : acquisition, merger, or consolidation of the Company.]

These rights of first refusal and co-sale will not apply to (i) non-cash transfers to family members or trusts, (ii) a transfer or transfers to any affiliate or (iii) a transfer or transfers by any Founder which in the aggregate do not exceed [1-10%] of the shares of Common Stock owned by such Founder [IF: on the date of the Closing] [CF: from time to time], provided in each case that the transferee agrees to abide by these provisions. The Investors and the Company will have similar rights to acquire shares which would otherwise be transferred involuntarily.

11.9 [Drag-Along Rights:] [IF: So long as the Investors own Registrable Securities representing at least [25-50%] of the Common Stock on a fully-diluted basis, the Investors shall have the right, in the event of a proposed sale of the Company to a third party (whether structured as a merger, reorganization, as set sale or otherwise), to require the Founders to transfer in such sale all of the Company securities then held by them. Such rights will terminate upon a [IF: Qualified IPO]. [CF: IPO] [CF: acquisition, merger, or consolidation of the Company.]

Key Person Insurance: Prior to the Closing, the Company will obtain a key person life insurance policy on ______, in the amount of $______, with the [IF: Investors] [CF: Company] as the beneficiary.

[Executive Search:] [The Company will use its best efforts to hire a [Chief Executive Officer] [Chief Financial Officer] acceptable to the Investors as soon as practicable following the Closing.]

[Special Indemnification:] [IF: To the extent that the Company is required to issue additional shares that are committed, promised, or outstanding and that are not included in the capitalization reflected on Exhibit [B] hereto, the Founders will indemnify and hold harmless the [Company] [Investors] against such issuance and will agree to reduce their own share ownership to make up the difference.]

OTHER MAT T E R S

Transfer of Rights: Any rights accorded to the Investors may be transferred to (i) any partner or retired partner of any Investor which is a partnership, (ii) any member or former member of any Investor which is a limited-liability company, (iii) any family member or trust for the benefit of any individual Investor, (iv) any transferee who acquires at least ______shares of Registrable Securities; or (v) any affiliated venture capital fund of an Investor; provided the Company is given written notice thereof.

Conditions Precedent: to Financing: With the exception of the “Exclusivity” and “Confidentiality” sections herein, this Term Sheet is not intended as a legally binding commitment of the parties, and any obligation on the part of the Investors is subject to the following conditions precedent:

1. Completion of legal documentation satisfactory to the Investors. 2. Satisfactory completion of due diligence by the Investors. 3. [Conversion of the Bridge Notes].

11.10 Finders: The Company and the Investors shall each indemnify the other for any bro k e r’s or finder’s fees for which either is responsible.

Legal Fees and Expenses: Counsel to [Investor] [the Company] will draft documents. The Company will pay the reasonable fees and expenses of [lawyer], counsel to Investor [CF: up to a maximum of $20,000.]

Exclusivity: In consideration of Investor’s commitment to devote substantial resources to a due diligence review of the Company and preparation of legal documents relating to this transaction, the Company agrees that during the period between its execution of this Term Sheet and [30-90] days thereafter (or such earlier date that Investor advises the Company in writing that Investor is electing to discontinue efforts with respect to an investment in the Company), it will not and will not permit any of its officers, directors, or agents acting on its behalf to: (i) take any action to solicit, initiate, encourage, or assist the submission of any proposal, negotiation, or offer from any person or entity other than Investor or the other Investors relating to the acquisition, sale, or transfer of any of the capital stock of the Company or the acquisition, sale, lease, license, or other disposition of the Company or any technology or any material part of the assets of the Company; (ii) offer to sell or transfer any of the capital stock of the Company or to sell, lease, license, or otherwise dispose of the Company or any material part of the technology or assets of the Company to any person or entity other than Investor or the other Investors; or (iii) disclose financial or other information relating to the Company other than in the ordinary course of its business to any person or entity other than Investor, the other Investors, or their agents and representatives. The Company acknowledges and agrees that the legal remedies available to Investor in the event the Company violates any of the foregoing covenants would be inadequate and that Investor shall be entitled to obtain specific performance, injunctive relief, and other equitable remedies in the event of any such violation.

Confidentiality: The Company recognizes that this Term Sheet is confidential and that disclosure of the provisions contained herein could cause irreparable harm to Investor and the other Investors. Accordingly, the Company, and each of the Company’s agents, officers, and directors acknowledge and agree that the terms, conditions, and contents of this letter will be kept confidential and will not be published or disclosed except in the following circumstances: (i) disclosure may be made to the Company’s directors, officers, employees, or representatives who need to know such information for the purpose of evaluating this proposed investment (it being understood that such persons shall be informed by the Company of the confidential nature of such information and shall be required to treat such information confidentially); or (ii) disclosure may be made with the prior written consent of all Investors.

11.11 Investor recognizes that the due-diligence materials provided by the Company to Investor are confidential and that disclosure of these terms could cause irreparable harm to the Company. Accordingly, Investor and its agents, officers, and directors acknowledge and agree that the terms, conditions, and contents of this letter will be kept confidential and will not be published or disclosed except in the following circumstances: (i) disclosure may be made to the other Investors and their directors, officers, employees, or representatives who need to know such information for the purpose of evaluating this proposed investment (it being understood that such persons shall be informed of the confidential nature of such information and shall be required to treat such information confidentially); or (ii) disclosure may be made with the prior written consent of the Company.

Expiration: This offer expires in its entirety unless signed and accepted by 5:00 PM [State or Time Zone] time, ______, 200_ _ _ _.

In Witness Whereof, the parties have executed this Term Sheet as of the date set forth below:

Agreed And Accepted:

[COMPANY NAME] [INVESTOR]

By: ______By: ______

Name: ______Name: ______

Title: ______Title: ______

Date: ______, 200_ _ _ _ Date: ______, 200_ _ _ _

11.12 [EXHIBIT A] [BRIDGE NOT E S ]

[Investor A] $______

[Investor B] $______

[Investor C] $______

[Investor D] $______

EXHIBIT [B] P O S T -CLOSING CAPITA L I Z A T I O N

AMOUNT OF COMMON STOCK FULLY-DILUTED INVESTMENT EQUIVALENTS PERCENTAGE OWNERSHIP

Common Stock Founders Employee Option Pool* Total Common Stock

Series A Preferred Investor Other Investors [Bridge Note Holders] **Total Series A Preferred

Totals 100.00%

* Available for issuance. 11.13 ** Assumes full [$____) million investment [including conversion of outstanding Bridge Notes]. A P P E N D I X 1 2 E X P L A N A T O R Y T E R M S H E E T ( S A M P L E 2 )

This term sheet summarizes the principal terms with respect to a potential private placement of equity securities of ______(the “Company”) by a group of investors led by ______. This term sheet is intended solely as a basis for further discussion and is not intended to be and does not constitute a legally binding obligation.

PROPOSED TERMS FOR PREFERRE D STOCK FINANCING OF (THE “COMPA N Y ” )

Amount: $______at [First] Closing; [$______at Second Closing prior to ______, 200_ _ _]

Type of Security: Series ______Preferred Stock (“Preferred”)

Price per Share: $______(“Original Purchase Price”)

Investors: ______(collectively, the “Investors”)

First Closing: [First] Closing on or around ______, 200_ _ _

Capitalization: Outstanding Pro Forma Common Stock Preferred Stock Options Reserved Outstanding and unexercised Available for grant Warrants Convertible notes/other securities

12.1 RIGHTS, PREFERENCES, PRIVILEGES, AND RESTRICTIONS OF PREFERRE D

Comment: Dividends typically range from 7% to 10% Dividends: Holders of Preferred shall be entitled to receive, prior to any payment of of the Original Purchase Price. Most dividends are dividends to holders of the Common Stock of the Company (the “Common Stock”), noncumulative. annual dividends payable in the amount of $______per share when and if declared by the Board of Directors. [or, which shall cumulate from year to year annually on the anniversary date of the closing whether or not declared by the Board.]

Comment: This is a simple participating pre f e rred, which Liquidation Preference: In the event of any liquidation or winding up of the Company, means that the funds remaining after payment of the the holders of the Preferred will be entitled to receive in preference to the holders of P re f e rre d ’s Original Purchase Price will be shared equally Common Stock an amount (“Liquidation Amount”) equal to the Original Purchase Price by the Common and Pre f e rred shareholders. As drafted, [or: plus all cumulated dividends]. After payment of the Original Purchase Price [or: plus all this provision is very favorable to investors because there cumulated dividends] to the holders of the Preferred, the remaining assets shall be is no cap on the amount they are to receive. distributed ratably to the holders of Common and Preferred on a common equivalent basis [ratably to the holders of Common Stock] [or] [ratably to the holders of Common and Preferred on a common equivalent basis until the holders of Preferred have received a total return in the liquidation of three times the Original Purchase Price after which any remaining amounts will be distributed ratably to the holders of Common]. A merger, acquisition, or sale of substantially all of the assets of the Company in which the shareholders of the Company do not own a majority of the outstanding shares of the surviving corporation shall be deemed to be a liquidation.

Conversion

⁄ Optional: The holders of the Preferred will have the right to convert their Preferred at their option, at any time, into shares of Common Stock. The total number of shares of Common Stock into which the Preferred may be converted initially will be determined by dividing the Original Purchase Price by the Conversion Price. The initial Conversion Price will be the Original Purchase Price. The Conversion Price will be subject to adjustment as provided in paragraph (iv) below.

12.2 Comment: The purpose of forcing conversion is to ⁄ Automatic Conversion: All of the Preferred will be automatically converted into clean up and simplify the Company’s capitalization Common Stock, at the then-applicable Conversion Price, in the event that (x) holders of a structure at the IPO. Company will want as much majority of the Preferred consent to the conversion to Common Stock or (y) upon the flexibility to force conversion (which generally means a closing of an underwritten public offering of shares of the Common Stock of the 50% threshold), particularly if trying to do IPO in Company at a public offering price per share (prior to underwriting commissions and volatile markets when market conditions may cause the expenses) of not less than [2 to 5] times the Original Purchase Price in an offering of not offering price to fall below the per-share price that will less than $20,000,000 (the “IPO”). force conversion. May need to address majority threshold if representing investor that does not own a majority of the preferred. Alternatives include a supermajority threshold or a series vote.

C o m m e n t : B road-based weighted average as shown is Antidilution Protection: The Conversion Price of the Preferred will be subject to most typical and favorable to the Company. An altern a t i v e adjustment to prevent dilution in the event that the Company issues additional equity is a narrow-based weighted average formula which looks securities at a purchase price less than the applicable Conversion Price. [Ratchet alternative: only at the outstanding stock (as opposed to all stock on The Conversion Price of the Series ______Preferred will be subject to a “full ratchet” a fully-diluted basis). Other, more rare, alternatives include adjustment to reduce dilution in the event that the Company issues shares at less than the a “ratchet” provision which is quite onerous from the Conversion Price. The then-effective Conversion Price shall be reduced to the price paid for C o m p a n y ’s perspective as it provides that, upon a down such newly issued shares.] The Conversion Price of the Preferred will be subject to round, the Conversion Price of the Pre f e rred is adjusted adjustment on a broad-based weighted average basis. The Conversion Price shall not be d o w n w a r d to the issuance price of the dilutive financing. adjusted because of (a) conversion of the Preferred, (b) securities issued to a commercial Another provision, the so-called “pay-to-play” provision, is lender or lessor which is approved by the [entire] board, (c) the sale or grant of options to b u r densome to the investors because it re q u i res that employees, directors, or consultants to purchase up to ______shares of common stock [or investors must participate in dilutive rounds to re t a i n the sale or grant of options to purchase shares approved [unanimously] by the Board of antidilution protection for their shares. Directors], (d) issuances in acquisitions of another company or assets unanimously approved by the Board, and [(e) any other issuance that is approved by the [entire] Board.] The Conversion Price will also be subject to proportional adjustment for stock splits, stock dividends, recapitalizations, and the like.

12.3 Voting Rights:

Other than Directors. The holders of a share of Preferred will have a right to that number of votes equal to the number of shares of Common Stock issuable upon conversion of Preferred.

Directors. The size of the board shall be set at ______. The holders of Preferred shall be entitled to elect ______directors. The holders of Common shall be entitled to elect ______directors. The remaining directors shall be elected by the Preferred and Common voting together.

Comment: The Company will typically resist a [Redemption at Option of Investor: At election of the holders of at least 50% of redemption feature on the theory that the expected the Pre f e r red, the Company shall redeem [1/3 of the Pre f e r red on the fifth anniversary liquidity will be achieved when the Company goes of the Closing, 1/3 on the sixth anniversary of the Closing and 1/3 on the seventh public or is acquired. The investors may insist on the a n n i v e r s a r y of the Closing], each at a redemption price equal to the Original Purc h a s e redemption feature to force the Company to cash them Price [plus a rate of re t u r n equal to 10% per year on the Original Purchase Price [or: out at some point if the other liquidity options (an IPO plus all cumulated dividends]] minus the amount of any dividends previously paid to or acquisition) have not occurred. holders of Pre f e r red.]

Comment: Need to consider threshold vote required: Protective Provisions: Consent of the holders of a [majority] of the outstanding Preferred The Company will generally favor a simple majority Stock shall be required for: (i) any amendment or change of the rights, preferences, threshold; however, if we represent the investors and privileges, or powers of, or the restrictions provided for the benefit of, the Preferred; the investors do not hold a majority of the outstanding (ii) increases or decreases the authorized number of shares of Common or Preferred Stock; preferred stock, may need consider a supermajority (iii) any action that authorizes, creates, or issues shares of any class of stock having threshold or a series vote. preferences superior to or on parity with the Preferred; (iv) any action that reclassifies any outstanding shares into shares having preferences or priority as to dividends or assets senior to or on parity with the preference of the Preferred; (v) any amendment of the Company’s Articles of Incorporation or Bylaws that adversely affects the rights of the Preferred; (vi) any merger or consolidation of the Company with one or more other corporations in which the shareholders of the Company immediately after such merger or consolidation hold stock representing less than a majority of the voting power of the outstanding stock of the surviving corporation; (vii) the sale of all or substantially all the Company’s assets; (viii) the liquidation or dissolution of the Company; (ix) the declaration or payment of a dividend on the Common Stock (other than a dividend payable solely in shares of Common Stock); 12.4 [(x) the license by the Company of any of its technology of such a manner as to have the same economic effect as a sale or disposition of all or substantially all of the assets of the Company;] (xi) the repurchase by the Company of any shares of its capital stock, except redemption or repurchase of shares of common stock from employees or consultants upon termination of their employment or service pursuant to agreements providing for such repurchase; or (xii) changes the authorized size of the Company’s Board [unless required during a future financing].

RIGHTS AGREEMENT R e g i s t r ation Rights:

Comment: Generally, holders of 30% to 50% must Demand Rights: If, at any time that is six months after the Company’s initial public demand registration. offering [or: If, at any time on or after two years from the Closing Date], holders of at least [40%] of the Preferred (or Common Stock issued upon conversion of the Preferred or a combination of such Common Stock and Preferred) request that the Company file a registration statement for all or any portion of the Common Stock issued or issuable upon conversion of the Preferred, having an aggregate offering price to the public of not less than [$5,000,000], the Company will use its best efforts to cause such shares to be registered, provided, however, that (a) the Company shall not be obligated to effect any such registration within 90 days prior to the filing of, and [90 to 180] days following the effective date of, a registration statement pertaining to an underwritten public offering of the Company’s securities, (b) such registration obligation shall be deferred not more than six months from the date of receipt of request from the initiating holders if the Company furnishes the initiating holders with a certificate of the Chairman of the Board stating that in the good-faith judgment of the Board, it would be seriously detrimental to the Company and its shareholders for such registration statement to be effected at such time, provided that the right to delay a request may be exercised by the Company not more than once in any 12-month period, and (c) the Company shall not be obligated to effect more than [two] such demand registrations. Any such registration shall be firmly underwritten by an underwriter of nationally recognized standing.

12.5 Comment: Registrations on Form S-3 not possible Registrations on Form S-3: Holders of at least 20% or more of the Preferred (or Common until one year after IPO; shorter form, much less Stock issued upon conversion of the Preferred or a combination of such Common Stock expensive. Ty p i c a l l y, offering must be between and Preferred) with proceeds of at least [$5,000,000] will have the right to require the $ 1 million and $5 million. Company to file one registration statement annually on Form S-3 with respect to Common Stock issued upon conversion of the Preferred.

Comment: Limit underwriter “cutback” after IPO; Piggyback Registration: The Investor [and ______, ______and ______typically 20-30%. (collectively, the “Founders”)] will be entitled to “piggyback” registration rights with respect to offerings registered by the Company, subject to the right of the Company and its Comment: Founders may be given limited or underwriters, in view of market conditions, to reduce (but to no less than 30% of any subordinate rights. Important to define Founders who offering after the IPO) the number of shares of the Investor [and Founders] proposed to be will have this right and who will be subject to Right of registered. [All shares proposed to be registered by the Founders shall be cut back prior to First Refusal and Co-Sale Agreement (see below). any reduction of the number of shares proposed to be registered by the Investor.]

Registration Expenses: The registration expenses (exclusive of underwriting discounts and commissions) of all demand registrations, Form S-3 registrations, and piggyback registrations will be borne by the Company.

Transfer of Registration Rights: The registration rights may be transferred to a transferee (other than a competitor of the Company) who acquires at least 10% of the Investor’s shares. Transfer of registration rights to a partner, affiliate, or related entity of the Investor will be without restrictions as to minimum shareholdings.

Comment: Underwriter “lock-up” provisions a r e Other Registration Provisions: Other provisions will be contained in the Rights typically 180 days for IPOs. Some investors want no Agreement with respect to registration rights, including cross indemnification, the more than 90 days agreed to in advance to preserve agreement by Investors if requested by the underwriter in a public offering not to sell any ability to negotiate a shorter lockup period with Common Stock that they hold for a period of 180 days following the effective date of the underwriters. This may, however, create a burden later registration statement for the IPO or 90 days following a subsequently public offering in getting numerous investors to agree to extend the (subject to all directors, officers, and holders of 1% or more of the Company’s securities period at the time of the IPO. entering into similar agreements), the period of time in which the registration statement will be kept effective, underwriting arrangements, and the like. Comment: Condition “lockup” on agreement of officers, directors and holders of 1% or more of the Company’s securities being subject to same restrictions.

12.6 C o m m e n t : If we re p resent the Company, we will want Granting of Subsequent Registration Rights: The Company shall not grant registration to be able to grant rights pari passu with the re g i s t r a t i o n rights to any third party that are superior to [or pari passu with] the registration rights set rights contained in the Rights Agreement. Investors forth in the Rights Agreement without the prior written consent of holders of a [majority] should agree to this if the new rights holders are cut- of the Preferred. back prior to any investor being cut-back.

C o m m e n t : Depending on composition of investors, may want a threshold other than a simple majority. Company will probably prefer a simple majority thre s h o l d .

C o m m e n t: The Company will want simpler term i n a t i o n Termination of Registration Rights: The registration obligations of the Company shall language, such as, “upon any three-month period when the terminate five years after the initial public offering. In addition, the registration rights will Investors can sell all of their shares pursuant to Rule 144.” terminate if (i) the Company has completed its IPO, (ii) an Investor (together with its affiliates, partners, and former partners) hold less than [1%] of the Company’s outstanding Common Stock (treating all shares of convertible preferred stock on an as-converted basis) and (iii) all such stock held by an Investor (and its affiliates, partners, and former partners) may be sold under Rule 144 during any ninety (90)-day period.

I n f ormation Rights:

Comment: Information rights and inspection rights So long as an Investor holds not less than [5% to 15%] of the total Preferred issued in the should have the same percent threshold. Will want financing (or Common Stock issued upon conversion of the Preferred or a combination of threshold high enough so that each small investor does such Common Stock and Preferred), the Company will deliver to the Investor audited not have these rights, but each primary investor does annual and unaudited quarterly financial statements. So long as the Investor holds not less have these rights. than _ _ _ _ _% of the total Preferred issued in the financing (or Common Stock issued upon conversion of the Preferred or a combination of such Common Stock and Preferred), the Comment: Sometimes information rights and Company will timely furnish the Investor with budgets and monthly financial statements. inspection rights will terminate if an investor begins These obligations of the Company will terminate upon a public offering of Common Stock converting some of its preferred stock. [or at such time as an Investor has converted more than [50%] of its Preferred into Common Stock].

12.7 Inspection Rights:

The Company shall permit an Investor that holds not less than _ _ _ _ _% of the total Pre f e rre d issued in the financing (or Common Stock issued upon conversion of the Pre f e rred or a combination of such Common Stock and Pre f e rred) to visit and inspect the pro p e rties of the C o m p a n y, including its corporate and financial re c o rds, and to discuss its business and finances with officers of the Company during normal business hours following reasonable notice.

Right of First Refusal:

Comment: Important to define the investors who will In the event the Company offers equity securities (other than (i) options reserved at the have this right (generally the same as the ones who Closing under the Company’s option plans, (ii) upon conversion of outstanding Preferred, have information and observation rights) and which (iii) upon exercise of outstanding options or warrants, (iv) in connection with an acquisition issuances of equity securities will not trigger this right. or a public offering that is approved by the [entire] board [, including the ______director], or (v) in connection with an equipment lease or commercial lending arrangement that has Comment: Sometimes investors will want right to been approved by the [entire] board [, including the ______director], each Investor who subscribe for more than their pro-rata portion, holds not less than _ _ _ _ _% of the total Preferred issued in the financing (or Common Stock including, in some rare cases, all of a future financing. issued upon conversion of Preferred or any combination of such Preferred and Common Stock) shall have a right of first refusal to purchase such portion of those equity securities as to maintain its pro-rata ownership interest in the Company. This right shall terminate upon the closing of an IPO or an acquisition of the Company [or at such time as an Investor has converted more than [50%] of its Preferred into Common Stock].

Miscellaneous Provision: Amendment/Wa i v er of Rights Ag r e e m e n t

Comment: Depending on composition of the investors, No right may be waived and the Rights Agreement may not be amended without the may want to adjust threshold, though Company will approval of the Company and the holders of a [majority] of the Preferred. prefer a majority threshold.

12.8 RIGHT OF FIRST REFUSAL AND CO-SALE AG R E E M E N T

Comment: The percent of stock that Founders may Right of First Refusal: Except for gifts to a spouse or children, or transfers to the estate of transfer free of any restrictions ranges from 1% to a deceased share h o l d e r, or transfers of up to [1% to 10%] of all of the Founder’s stock 10%; generally, 5% is standard. (including all pre f e rred and common stock), a Founder may not transfer any shares of the C o m p a n y ’s capital stock now owned or hereafter acquired without first offering it to the Company and then to the Investors. [If an Investor does not exercise its pro-rata right, other Investors that exercise their right may purchase the non-participating Investor’s port i o n . ]

Put Right: In the event a Founder transfers his shares in violation of this Right of First Refusal and Co-Sale Agreement, the Investors shall have the right to put a pro-rata portion of their shares to such Founder.

FOUNDER S TO C K -RESTRICTION AG R E E M E N T

Comment: The release of Founder’s shares from Each Founder will execute a stock-restriction agreement with the Company pursuant to Company right of repurchase is highly negotiated at the which the Company will have a repurchase option to buy back at cost a portion of the time of first venture financing. Generally, the Founder shares of stock held by such person in the event that such shareholder’s employment with will be given some credit for work done prior to the Company is terminated, prior to the expiration of _ _ _ _ _ months from the date of the financing so not all Founder’s shares will be subject to Preferred Stock Purchase Agreement (the “Measuring Date”). A portion of the shares will right of repurchase. The Founder’s remaining shares will be released from the repurchase option based upon continued employment by the be released from the repurchase option either monthly Company as follows: [_ _ _ _ _% will be released from the repurchase option as of the date of thereafter (which is typical) or some portion one year the Preferred Stock Purchase Agreement; an additional _ _ _ _ _% will be released from the after the financing and then monthly thereafter. repurchase option on the first anniversary of the Measuring Date, and an additional _ _ _ _ _% will be released on the completion of each month thereafter.]

12.9 OTHER AGREEMENTS AND CONDITIONS

Comment: You will need to think through the The Pre f e rre d Stock Purchase Agre e m e n t : The purchases of the Pre f e rred will be made representation and warranties. Generally, Investors want pursuant to a Pre f e rred Stock Purchase Agreement reasonably acceptable to the Company cleaner reps and warranties with fewer qualifiers and the Investors, which agreement shall contain, among other things, appro p r i a t e (knowledge and materiality), while the Company will re p resentations and warranties of the Company, covenants of the Company reflecting the want fewer reps and warranties and more qualifiers. p rovisions set forth herein and appropriate conditions to closing which will include, among other things, qualification of the shares under applicable Blue Sky laws, the filing of Amended and Restated Articles of Incorporation, and receipt of an opinion of counsel. The Pre f e rre d Stock Purchase Agreement shall provide that it may only be amended and any waivers t h e reunder shall only be made with the approval of the holders of a majority of the Pre f e rre d .

Proprietary Information and Inventions Agreement: Each officer and employee of the Company will enter into a proprietary information and inventions agreement with the Company.

Comment: Key-man insurance is good source of funds Key Man Insurance: [$1,000,000] policy on the lives of each of the Founders, with the for redemption in early-stage company, if investors have Company as beneficiary [but with proceeds to be applied to redemption of Preferred Stock requested the right of redemption. at the election of holders of the majority of Preferred.]

Finders: The Company and the Investors shall each indemnify the other for any broker’s or finder’s fees for which either is responsible.

Comment: Investor’s counsel usually capped between Expenses: The Company and the Investors will each bear their own legal and other $10,000 and $30,000. expenses with respect to the transaction (except that, assuming a successful completion of the transaction, the Company will pay reasonable legal fees and expenses incurred by counsel to the Investors, up to $______).

12.10 Comment: If representing the Company, try to delete The Closing: The Closing of the purchase of the Preferred will be conditioned upon bracketed language re [in their sole discretion]. the following:

⁄ Completion of due diligence to the satisfaction of the Investors [in their sole discretion]; ⁄ Compliance by the Company with applicable securities laws;

⁄ Opinion of counsel to the Company rendered to the Investors in form and substance satisfactory to the Investors and their counsel;

⁄ [Other material conditions];

⁄ Such other conditions as are customary for transactions of this type.

C O R P O R A TE INVE STO R S

Comment: Should receive careful consideration when a Confidentiality [and Standstill]: Each corporate investor will enter into a confidentiality corporate investor is investing. agreement covering standard information disclosed by the Company [and a standstill agreement for a period of five years] [and will enter into a voting agreement agreeing to vote all shares [in the event of a merger or acquisition of the Company or a sale of all assets] in the same manner as the majority of all other shareholders]. Further, to avoid conflicts of interest, any director [or observer] affiliated with such investor may be excluded from any portion of any Board meeting when the majority of the other Board members deems it to be appropriate to protect the interests of the other stockholders.

12.11 OTHER MAT T E R S

In consideration of the Investors’ commitment of substantial resources to perform and complete a due-diligence review of the Company, the Company agrees that during the period between the acceptance of this Term Sheet and ______, 200_ _ _, the Company shall not enter into or continue discussions with any third party, either agent or principal, concerning a possible investment, public offering, merger, acquisition, or other business arrangement. If for any reason the Investors decide not to proceed with this investment, they will provide immediate written or verbal notice to management of the Company, and all terms, including the "exclusivity" outlined above, will terminate upon such notice.

This offer will expire if not accepted by ______.

Agreed and Accepted

______[Company] [Investors]

Date:______Date:______

Counsel for the Company is:

Counsel for the Investors is:

12.12 A P P E N D I X 1 3 A N G E L S A N O N Y M O U S 1 P U B L I C S U R V E Y

Note: A better understanding of public perception and opinion can help in the growth and sustainability of your angel g roup. Numerous perspectives would be most valuable and may be better distributed in separate surveys to those selected groups. As such, the survey below contains sections directed at diff e rent audiences, which you may wish to separate into diff e rent market-specific surveys. Obviously, you will want to add questions unique to your group or c o m m u n i t y. Remember to keep the survey simple and easy to respond (minimal time). Many organizations use on-line s u rveys, which can make response quite efficient and may even have features for automatic data compilation. Let your audience know that individual results will be kept confidential and only compiled results will be shared publicly.

Scoring: 1= Unsatisfactory 2= Weak 3= Satisfactory 4= Good 5= Excellent NI=No Information

GENERAL AUDIENCE AND/OR MEMBERSHIP SCORE

1. How did you first hear of Angels Anonymous? (check all that apply) ■ F r ie n d / p e r s o nal acqua i nt a nc e ■ News media ■ Professional acquaintance ■ Investment event ■ AA Web site ■ VC or investment banker ■ Company applied to AA ■ Company received AA investment ■ Other:______

2. What has your impression been of AA in: a. Membership criteria and standards? 1 2 3 4 5 NI b. Membership experience and expertise? 1 2 3 4 5 NI c. Attention to membership needs? 1 2 3 4 5 NI d. Ability to gain information about AA? 1 2 3 4 5 NI e. In comparison, overall, to other angel groups? 1 2 3 4 5 NI

3. In what industry(s) do you believe AA members invest? (check all that apply) ■ Health care ■ Telecommunications ■ Media ■ Manufacturing ■ Environment ■ Biotechnology ■ Business/Financial ■ Energy ■ E-Commerce ■ Industrial ■ Software ■ Consumer products ■ Agriculture ■ Semiconductors ■ Other:______

1 “Angels Anonymous” is a fictitious angel group and is merely a name used 13.1 for example purposes. GENERAL AUDIENCE AND/OR MEMBERSHIP (continued) SCORE

4. What is your impression of AA’s investment criteria? 1 2 3 4 5 NI

5. What is your impression of AA’s investment rate? (i.e., number of deals done) 1 2 3 4 5 NI

6. How would you compare AA to other angel groups? 1 2 3 4 5 NI

7. How would you compare AA to venture capital funds? 1 2 3 4 5 NI

8. Considering angel organizations in general, rank the following statements with regard to your understanding of group function or role in funding companies: (Rank with 1 highest)

____ Primary funding source for entrepreneurs

____ P r i mary fund i ng source for small companies with mo dest re v e nue potent ial (less than $20 millio n )

____ Companies in which angel groups invest in nearly always need venture capital or some further institutional investment

____ Companies in which angel groups invest in nearly always get venture capital or some further institutional investment

____ Angel groups are competitive to venture capitalists

____ Angel groups are essentially the same as venture capitalists

APPLYING COMPANIES

1. How did you find out about AA? (check all that apply) ■ Friend/personal acquaintance ■ News media ■ Professional acquaintance ■ Investment event ■ AA Web site ■ VC or Investment banker ■ Company which applied to AA or received AA investment ■ Other: ______

2. Did you find the information-submission requirements understandable? 1 2 3 4 5 NI

3. Did you understand the screening and selection criteria? 1 2 3 4 5 NI

4. Did you understand the screening and selection process? 1 2 3 4 5 NI

5. Were you chosen for presentation? ■ Yes ■ No

13.2 APPLYING COMPANIES (continued) SCORE

6. If you were chosen for presentation, how valuable was the presentation coaching? 1 2 3 4 5 NI

7. Whether or not you were chosen for presentation, did you find the feedback provided 1 2 3 4 5 NI valuable and substantive?

8. Did you understand the reasons you were, or were not, chosen to present? ■ Yes ■ No ■ Somewhat

9. Was your interaction with AA constructive for your company? 1 2 3 4 5 NI

10. If you were selected as a presenter, did you receive any funding from an AA member? ■ Yes ■ No

11. If you were selected as a presenter, did you receive any funding from any other investors? ■ Yes ■ No

12. Please indicate the stage of your company at this time: (check one that applies) ■ Start-Up: idea stage, no product or sales ■ Seed: initial development, but no products sold ■ Early: most product development done and initial sales begun ■ Developmental: product development mature and focused on selling

13. As a source of funding, how would you compare AA to: a. Other angel organizations 1 2 3 4 5 NI b. Venture capitalists 1 2 3 4 5 NI c. Traditional banks 1 2 3 4 5 NI

14. Would you recommend AA to other entrepreneurs? ■ Yes ■ No

13.3 4 8 0 1 R O C K H I L L R O A D

K A N S A S C I T Y, M I S S O U R I 6 4 1 1 0

8 1 6 - 9 3 2 - 1 0 0 0 | www. k a u f f m a n . o r g

©2004 Ewing Marion Kauffman Foundation. All rights reserved.

08041M